Whenever a business faces financial difficulty, it is easy to assume that the company simply isn’t profitable. In many cases this is quite true of course, particularly in recent times. But this is not necessarily the case, and conversely many businesses can rack up significant losses for years and still survive. Every business ultimately needs to make profit to be viable, but a second vitally important factor is cash flow.
There is a big difference between the amount of profit a company makes and the increase in its bank balance, because money does not necessarily change hands at the point at which the expense was incurred. Supposing you provide a service to other businesses – although you might invoice them all at the end of the month, it might be weeks if not months before your customers pay up (if indeed they pay up at all!) It works the other way as well of course – if you run a shop, you will normally be paid upfront by your customers, but your suppliers might give you 30 days or more to pay up, which gives your cash flow a useful boost.
The biggest headache for many businesses is taxes such as VAT, PAYE, income tax and corporation tax. These expenses are often accrued over a period of weeks and months, and can take business owners by surprise when they finally become due. It is usual practice to advise new business owners to put 20% of their earnings aside for tax, but it can be very tempting to dip into any such savings, particularly during difficult periods, and this can leave businesses in trouble when the tax man comes knocking on the door.
Another habit of many business owners is to draw more money for themselves than their business can technically afford. If there is £10,000 in the bank, it can be tempting indeed to draw some or all of this as a salary or bonus, only to be hit with a large unexpected bill for stock, rent, professional fees or taxes, and find that the money isn’t there to cover such costs.
It can be very difficult to predict the cash flow of a business, even if it is doing well. Banks know this, of course, and they will think nothing of taking advantage of this by charging extortionate fees for bounced payments and unauthorised overdrafts. This only makes matters worse, and can be the start of a downward spiral.
Although it is impossible to predict your company’s cash flow situation exactly, there are steps that can be taken to minimise the risk of simply running out of money, which can put a great strain on the business or even force it to close.
1. Prepare budgets. There is software available that calculates estimated profit & loss and cash flow over a given period of time, or a spreadsheet can be used to show how the bank balance is likely to look over the next few months or years. Particular attention should be paid to months where cash flow is likely to be a problem, such as when a large tax bill becomes due, or during a period of low sales.
2. Keep enough cash in the bank. Not always easy or even possible, but aim to have enough cash reserves in the bank to cover all eventualities, and don’t be tempted to draw large sums of cash unless the business can really afford it.
3. Have other sources of funding available as a backup. This could be something as simple as an overdraft arranged with the bank. It is always worth trying to get such a facility even if you don’t intend to use it, otherwise you’ll be hit with excessive charges every time to go over by so much as a groat. Alternatively make use of any cheap credit facilities – pay for things on credit card but pay it on time and in full, or take advantage of credit terms offered by suppliers. Better still, keep money in savings that can be drawn in an emergency.
4. Plan ahead. If you know you have to pay a large VAT bill next month, it might be worth putting off payment of something else until the following month. Some expenses, such as staff wages, are unavoidable, but you might get away with paying a supplier a few days late once in a while.
5. Work with people during times of crisis. If it looks like you are entering a sticky period financially, consider contacting your bank, suppliers or tax office and see what they can do to help. Perhaps your bank could offer you a loan to clear your overdraft, or maybe a supplier will accept monthly payments of an agreed amount to ease the pressure. Better to negotiate than to face the prospect of large financial penalties, withdrawal of services or threats of legal action, which are all too common.
Careful cash flow planning is even more important for new businesses as it can be very easy to run out of money in the early days. Set-up costs can run into many thousands even for small businesses, and sales are often very modest in the early days while the business builds up its reputation. It is therefore vital to ensure enough funding is put in place at the start, not just to cover set-up costs, but also to keep the business afloat in the early months when it may well trade at a loss.
More information on business planning, sources of funding and cash flow management can be found on the Business Link website at www.businesslink.gov.uk, or visit the website of N S Accountancy, providing bookkeeping and accountancy services in the North East.