Cash is the lifeblood of all businesses. While it is possible to survive the difficult early years without much profit, it's impossible to thrive without cash to pay the bills and allow trading to continue.
Effective cash management is particularly important to growing businesses. Supplying new customers will often mean granting them credit, so you will need to be able to cover your costs until they pay you.
Effective cashflow management means keeping a careful eye on your cash position at all times. You will need to create and manage systems that enable you to predict with confidence when and how you are going to receive payment from your customers, pay your bills and generate your profits.
Cashflow is the actual payments of money, as opposed to what is owed to you by your debtors or by you to your creditors.
If you sell on credit, your cash inflow is delayed until you are actually paid. Effective credit control is essential (see section 5).
A business that purchases on credit and is paid in cash, such as a retailer, is at a great advantage in cashflow terms.
Salaries (including National Insurance contributions) are often the largest and most inflexible cost.
Other major costs include stock, raw materials and any capital expenditure.
Many businesses have to fund large amounts of work-in-progress.
These should show the level of sales and profits you expect to achieve, and the costs these create.
Estimate the sales and margins, based on past experience, if possible.
Overheads such as rent can be accurately predicted.
Identify the major outgoings, especially those on fixed dates, such as the monthly payroll. Make sure you will have sufficient cash on the day before each payment is due.
Be realistic. For your regular sales, use established figures for sales volumes, debtor periods and bad debts. For any new products or customers, be pessimistic - expect problems and delays and do not book a sale until the customer has paid the invoice.
Remember that monthly forecasts do not take weekly fluctuations into account.
You can quickly update your projections and make 'what if' calculations. (eg what if sales are 20% below forecast for six months in a row?).
You could use tables and charts to make it easy to detect patterns and changes to cashflow.
For example, the volume and status of sales leads and the volume of orders.
Don't be overly optimistic in your sales forecasts. A bank which trusts your forecasts will be more prepared to extend your borrowing facility when you need extra finance.
You must always have sufficient cash to pay these on time.
You can be penalised heavily for late payments.
If you are VAT-registered, buy significant items just before a VAT period ends, rather than at the start of the next one, to help your cashflow.
You should do this at least once a month.
Identify any problems and take immediate action.
By comparing your performance with the budget, you can quickly judge whether sales and profits are going to plan.
This includes major new orders.
Create a useful yardstick by working out how much extra working capital is required to fund each 10% increase in monthly sales.
Restrict the growth of your business to levels you can comfortably afford to finance. Always keep a financial reserve as a contingency fund, should an emergency occur.
You need to know if leads, orders or sales fall below a certain threshold, if planned sales will be later than forecast, or if a substantial customer stops buying from you as early as possible.
You also need to know when key indicators, such as profit margins, liquidity ratios and stock ratios, deteriorate beyond an agreed limit. In addition you want to monitor any substantial invoices which are in dispute, late debts and customers exceeding their credit limits.
Build productive relationships with your key suppliers so they are prepared to extend extra credit to you when you need it.
Increasing prices may reduce sales (and therefore cashflow) in the short-term. But this is often outweighed by its major positive impact on profitability and cash generation over the longer term.
Even profitable companies can (and do) become insolvent through overtrading. This happens when you have to pay the costs you incurred fulfilling an order before you receive payment from your customer.
To avoid this risk, you might need to delay some orders and decline others.
You may be surprised how easy it is to obtain deposits. For example, to pay for materials you need to buy in.
Negotiate stage payments for contracts that will take time to complete. Include a timetable for the customer to pay invoices as part of this agreement.
Agree a clear specification for the work to be completed, to minimise the customer disputing any invoices and delaying payment.
Suppliers are often asked to perform beyond their original remit. It is reasonable to negotiate additional payments in these circumstances.
Ask to be paid directly via BACS, which delivers cleared funds.
Bring forward sales by offering customers incentives to purchase quickly.
Bring forward payments by offering customers incentives (eg discounts).
Focus your marketing on short-term lead generation, rather than longer term objectives like brand recognition.
This will encourage your sales people to persuade customers to pay promptly.
Avoid giving any customer more credit than you could afford to lose if the sale turned into a bad debt.
If appropriate, make a follow-up call.
Confirm that all the invoice details were correct and that there will be no problem paying it by the due date. Plan ahead for holidays and Christmas.
You should pursue your largest debtors first.
All businesses (and the public sector) have a legal right to charge late-paying customers interest on contracts.
Using a debt collection agency, or a specialist solicitor, can be an effective method of dealing with non-payers.
If you know the current best prices and service levels, you can insist on better terms from your suppliers.
Consider whether you could make savings by purchasing some types of capital equipment second-hand.
Easy savings can usually be found. For example:
Effective stock control can free up significant amounts of cash.
Aim to maintain just enough of each type of stock to service your customers on an ongoing basis. Identify seasonal peaks and troughs.
Set a target stock-turn (eg every two months) for each category of stock, then monitor your performance.
The faster your suppliers can deliver to you, the less stock you need hold.
Consider selling off any old or obsolete stock to free up capital.
Consult your bank manager to find out the most favourable arrangement for your business.
This allows you to raise finance based on the value of outstanding invoices.
Growing businesses often find that factoring provides a more substantial and flexible source of working capital than overdrafts or loans.
Hire purchase and leasing allow you to spread the cost of the acquisition, with the asset itself providing the main security.
Subsequent injections of equity finance can help you achieve step changes in the growth of the business. For example, if you need extra finance to buy another firm or open a new factory.
Check whether it will result in a profit or loss, otherwise you risk generating cashflow to the detriment of your profit and loss account.