Cash Flow Management for Small Business

For any small business the availability of cash and a healthy cash flow in the business is probably one of the most important elements. As the business owner, its crucial that you manage both the money going out and of course the money coming into the business. To often as entrepreneurs we are just so thankful to be making sales that we will happily be giving both discount and credit to those kind enough to be purchasing out products or services. If you are selling products, you may as well be asking people to take your money and hope they are in the position to give it back at some point in te future. Of course their are also a number of other key cash flow practices necessary in small firms to ensure first of all existence and hopefully later growth. We will be looking at the issues involved in this in  te rest of the article.

What is cash?
Cash flow is the measure of your ability to pay your bills on a regular basis. It depends on the timing and amounts of money flowing into and out of the business each week and month. Good cash flow means that the pattern of income and spending in a business allows it to have cash available to pay bills on time.

Your available cash includes:
coins and notes
money in current accounts and short-term deposits
any unused bank overdraft facility
foreign currency and deposits that can be quickly converted to your currency

It does not include:
long-term deposits (if these cannot be withdrawn)
money owed by customers

Difference between cash and profit
It is important not to confuse cash balances with profit. Profit is the difference between the total amount your business earns and all of its costs, usually assessed over a year or other trading period. You may be able to forecast a good profit for the year, yet still face times when you are strapped for cash.

The importance of cash
To make a profit, most businesses have to produce and deliver goods or services to their customers before being paid. Unfortunately, no matter how profitable the contract, if you don't have enough money to pay your staff and suppliers before receiving payment from your customers, you'll be unable to deliver your side of the bargain or receive any profit.

To trade effectively and be able to grow your business, you need to build up cash balances by ensuring that the timing of cash movements puts you in a positive cashflow situation overall.
But bear in mind that having a lot of cash in your bank does not necessarily make good business sense. If you do not need to use it immediately, put spare cash into an account where it will earn a higher rate of interest, or use it as capital for short-term investments.

Cash inflows and cash outflows
Ideally, during the business cycle, you will have more money flowing in than flowing out. This will allow you to build up cash balances with which to plug cashflow gaps, seek expansion and reassure lenders and investors about the health of your business.
You should note that income and expenditure cashflows rarely occur together, with inflows often lagging behind. Your aim must be to speed up the inflows and slow down the outflows.

Cash inflows
Payment for goods or services from your customers.
Receipt of a bank loan.
Interest on savings and investments.
Shareholder investments.
Increased bank overdrafts or loans.

Cash outflows
Purchase of stock, raw materials or tools.
Wages, rents and daily operating expenses.
Purchase of fixed assets - PCs, machinery, office furniture, etc.
Loan repayments.
Dividend payments.
Income tax, corporation tax, VAT and other taxes.
Reduced overdraft facilities.

Many of your regular cash outflows, such as salaries, loan repayments and tax, have to be made on fixed dates. You must always be in a position to meet these payments in order to avoid large fines or a disgruntled workforce.
To improve everyday cashflow you can:
ask your customers to pay sooner -
chase debts promptly and firmly -
use factoring -
ask for extended credit terms with suppliers -
order less stock but more often - see our guides on
lease rather than buy equipment -
improve profitability -

You can also improve cashflow by increasing borrowing, or putting more money into the business. This is suitable for coping with short-term downturns or to fund growth in line with your business plan, but shouldn't form the basis of your cash strategy.

The principles of cashflow forecasting
Cashflow forecasting enables you to predict peaks and troughs in your cash balance. It helps you to plan borrowing and tells you how much surplus cash you're likely to have at a given time. Many banks require forecasts before considering a loan.

Elements of a cashflow forecast
The cashflow forecast identifies the sources and amounts of cash coming into your business and the destinations and amounts of cash going out over a given period. There are normally two columns listing forecast and actual amounts respectively.

The forecast is usually done for a year or quarter in advance and divided into weeks or months. In extremely difficult cashflow situations a daily cashflow forecast might be helpful. It is best to pick periods during which most of your fixed costs - such as salaries - go out. The forecast lists:
excess of receipts over payments - with negative figures shown in brackets
opening bank balance
closing bank balance

Note that all forecast figures must relate to sums that are due to be collected and paid out, not invoices actually sent and received. The forecast is a live entity. It will need adjusting in line with long-term changes to actual performance or market trends.

Accounting software
Accounting software will help you prepare your cashflow forecast, allowing you to update your projections if there's a change in market trends or your business fortunes. Planning for seasonal peaks and troughs is simplified and you can also make 'what if' calculations. Most banks require profit and balance sheet forecasts as well as cashflow. Many accounting packages will assist with preparing these documents.

Manage income and expenditure
Effective cashflow management is as critical to business survival as providing services or products. Below are some of the key methods to help reduce the time gap between expenditure and receipt of income.

Customer management
Define a credit policy that clearly sets out your standard payment terms.

Issue invoices promptly and regularly chase outstanding payments. Use an aged debtor list to keep track of invoices that are overdue and monitor your performance in getting paid.

Consider exercising your right to charge penalty interest for late payment.

Consider offering discounts for prompt payment.

Negotiate deposits or staged payments for large contracts. It's in your customers' interests that you don't go out of business trying to meet their demands.

Consider using a third party to buy your invoices in return for a percentage of the total.

Supplier management
Ask for extended credit terms. Giving your suppliers incentives such as large or regular orders may help, but make sure you have a market for the orders you're placing.

Cashflow problems and how to avoid them
No matter how effective your negotiations with customers and suppliers, poor business practices can put your cashflow at risk.

Look out for:
Poor credit controls - failure to run credit checks on your customers is risky, especially if your debt collection strategy is inefficient.

Failure to fulfil your order - if you don't deliver on time, or to specification, you won't get paid. Implement systems to measure production efficiency and the quantity and quality of stock you hold and produce.
Ineffective marketing - if your sales are stagnating or falling, revisit your marketing plan.

Inefficient ordering service - make it easy for your customers to do business with you. Where possible, accept orders over the telephone, email or internet. Ensure catalogues and order forms are clear and easy to use.

Poor management accounting - keep an eye on key accounting ratios that will alert you to an impending cashflow crisis or prevent you from taking orders you can't handle.

Inadequate supplier management - your suppliers may be overcharging, or taking too long to deliver.

Poor control of gross profits or overhead costs - assess where you can cut costs.
Consider outsourcing non-core activities such as payroll services. Review your utilities contracts to see whether it is possible to reduce costs by switching tariff or supplier.

Using your cashflow forecast as a business tool
A cashflow forecast can be an invaluable business tool if it is used effectively. Bear in mind that it is dynamic - you will need to change and adjust it frequently depending on business activity, payment patterns and supplier demands.

It's helpful to set up a regular review of the forecast, changing the figures in light of your sales, purchases and staff costs. Legislation, interest rates and tax changes will also impact on the forecast.
Having a regular review of your cashflow forecast will enable you to:
see when problems are likely to occur and sort them out in advance
identify any potential cash shortfalls and take appropriate action
ensure you have sufficient cashflow before you take on any major financial commitment

Using a cashflow forecast to avoid overtrading
Having an accurate cashflow forecast will help ensure that you can achieve steady growth without overtrading. You will know when you have sufficient assets to take on additional business - and, just as importantly, when you need to consolidate.

It is important that you incorporate warning signals into your cashflow forecast. For example, if predicted cash levels come close to your overdraft limits, this should sound an alarm and trigger action to bring cash back to an acceptable level.

Ideally, you should always have a contingency plan, such as retaining a minimum amount of cash in the business, perhaps in an interest-earning account. This 'rainy day' money can be used to meet short-term cash shortages.

Refinements to a simple cashflow forecast
There is no single best way to set out a cashflow forecast. However, some refinements to the most basic ways of setting out the information will give you a more sophisticated view of your business' situation.
You could, for example, separate cashflow for business operations from funding cashflow. This gives a clearer picture of the actual performance of your business and is a format that many accountants prefer.

Cashflow from operations

Includes inflows such as:
cash sales
receipts from credit sales in earlier periods
interest on savings

Includes outflows such as:
payments to suppliers
hire purchase and lease payments
expenses - rent, rates, insurance, utilities, telephone, etc
taxes and National Insurance contributions
interest on loans and bank charges

Funding cashflows
Includes inflows such as:
loans from banks
increase in share capital

Includes outflows such as:
dividends paid
loans repaid
With these two types of cashflow separated you can gauge how self-sufficient the day-to-day working of your business is. A net outflow in operational cashflow is usually an indicator of problems that need to be addressed quickly.


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