Cash flow management

Glowing graphics and text on a dark backgroundManaging cash flow is key to running a successful business. Nicola Laver discusses the importance of managing cash flow and maintaining robust financial management and reporting for survival and growth

Cash flow can make or break a business. Worryingly, around half of small businesses do not survive beyond their first five years as a direct result of poor cash flow, the Office for National Statistics (ONS) found in its most recent business statistics report1. The report revealed that there were 351,000 business ‘births’ and 246,000 business ‘deaths’ in 2014.

The stark reality is many businesses are failing not because their business is inherently flawed, or because there’s something wrong with it – but because the cash dries up.

Accessing finance is undoubtedly a key issue for SMEs and start-ups. SMEs need to buy their inventory, and pay wages, creditors and suppliers. They also have tax and VAT bills to pay. Poor cash flow is undoubtedly the cause of many a business failing, as the ONS has found. The blame can largely be laid at the feet of the prevailing late payment culture which continues to be a major headache for SMEs. Business owners are spending valuable time chasing late payments, and not spending that time running the business.

Understanding how to manage and maintain a healthy cash flow, along with knowing about the array of alternative sources of finance available to businesses today, is vital to the survival of small businesses in a highly competitive marketplace.

The bottom line is that cash is king for SMEs. This means effective, robust cash flow and financial management is vital to their survival.

Cash flow management
Cash flow is, essentially, the movement of cash in and out of the business. The aim is to maintain positive cash flow as much as possible, i.e. the amount of cash entering the business is greater than the amount leaving the business. Achieving and sustaining positive cash flow is a constant challenge to businesses, and it is rarely a simple task.

Businesses need to pay close attention to what is going on in their business, identifying issues such as where the cash is going, what cash is actually coming in, and what cash is due to come in but has not materialised. Being diligent in watching this cash flow means a business can better identify where savings can be made, where spending can be cut, and where alternative finance may prove invaluable.

The goal of every business, however small, is to increase the amount of cash coming in month on month, year on year. Billing promptly is one thing, but getting the bills paid promptly is a perennial problem for many businesses. Typically, the larger the order from the supplier, the longer the payments terms – with clear implications for the business’s cash flow.

Effective management of a business’s cash flow, whether from within the business, or through accessing external finance – is key to stability and success. Higher sales means higher costs, so as your business grows, businesses need an increasing amount of cash to sustain it. Whilst cash is king – information is key. Keeping track of the key financial information of a business makes it easier to prepare and plan both for potential surges in cash, as well as periods of time when suppliers or customers are unlikely to be making payments.

Robust financial management and reporting
Alongside effective cash flow management is the regulatory need for robust financial management and reporting. Financial management extends beyond managing a business’s cash flow, and encompasses tracking the overall financial performance and forecasts of the business. Effective financial management is, in fact, at the heart of any successful business.

In a recent report, the Association of Chartered Certified Accountants (ACCA) sets out key steps for entrepreneurs and SMEs to achieve their goals2:

Effective planning starts with deciding what you are trying to achieve and takes this all the way through to creating a realistic plan. It should encompass all the following aspects:

Your long-term goal. What really matters to you? What is the purpose of your business? As your business reacts to changing circumstances, how will you keep on track? 

Your objectives. What would you like to achieve in the next 12 months, 24 months and 36 months? Why have you chosen these targets, now? Is there an opportunity you want to exploit, and why do you think it exists? What are others in your market doing?

The strategy. How can you take best advantage of the opportunities you have identified? What are the key risks and how can you control them? What assumptions have you made and what would it help to know? 

Tactics. How will you put your strategy into action? Who will do what, when?

Financial review. Can you afford your plans? Which tactics are likely to be the most cost-effective? How will you monitor progress?

Maintaining and implementing effective financial control in a business is clearly a challenge if there are a small number of staff. That said, there is no room for complacency: basic record-keeping is absolutely essential. Keeping track of purchases and sales is, of course, key – but these transactions can provide useful information. The data can tell you, for instance, whether you have opportunities to save or divert money; where your largest market is; and who are your fastest payers. The data may tell you whether your sales targets are being met; if you should (or could) invest in better technology to help streamline your business functions; and whether you have a surplus of cash that you could use effectively elsewhere in the business.

Effective financial control also requires businesses to look to the future: businesses are continually seeking to scale-up to become even more successful and profitable. If necessary, further finance can be secured to facilitate upwards growth of the business. Looking ahead means you can plan now – or, at least, plan when your financial data indicates that you need to. Cash flow management is one of the vital factors necessary to enable a business to look ahead and plan. Cash flow forecasts should be forming a basic part of the business’s current budgeting and planning.

Businesses need to make decisions to control their expenditure, and raise finance. When a business needs to raise finance from external investors, potential investors will be looking to examine your cash flow forecasts and other data before making their decision whether to invest. 

Business owners need to understand how to measure and forecast profit and cash, and the role of technology in facilitating efficient and effective financial control cannot be underestimated. As a business grows, the technology it uses for cash flow and financial controls may well need to be replaced with more sophisticated technology. This will require investment but it will undoubtedly prove invaluable in facilitating speedier, more accurate, and more complex record keeping and financial forecasting for the business.

Regulatory compliance
The compliance burden on business in respect of their legal and regulatory obligations can be burdensome but must not be compromised. Maintaining accurate records of sales and purchases is vital for completing VAT and corporation tax returns (with potential fines for underpayments). Understanding your cash flow and planning ahead is vital for effective tax planning.

The new UK GAAP for small and ‘micro entities’ was issued in July 2015, representing a new set of standards for small and micro-entities. It applies to accounting periods commencing on or after 1 January 2016, but for accounting periods commencing on or after 1 January 2015 (but before 1 January 2016) if the directors wish. SMEs have a choice of three standards which they can apply when preparing their financial statements – FRS 105 for the smallest of companies. Businesses should consult their accountants for detailed advice on this.

An important issue that business owners need to remember is that the line between business and personal finance can become blurred – particularly in the case of micro business and entrepreneurs. It is vital to maintain a distinction in your financial records of personal loans to, and drawings from the business – keeping personal loans from the business to a minimum.

It is vital that businesses understand that robust cash flow and financial management is key to driving improvements in the business, and maintaining business success and sustained growth.

Tips for Good Financial Management and Maintaining Cash Flow

Managing the business’s cash flow is not always easy. Following a few principles can help simplify it:

Map the finances out on a weekly, monthly and quarterly basis. This will enable you to forecast potential cash surpluses, and periods when little money will arrive.

Delegate book keeping and other basic functions where possible to enable business owners to get on with their core business functions.

Always understand suppliers’ payment terms: discounts for early payments may not be automatic. This brings you back to the need to accurately predict when the cash should come in.

Make sure your paperwork is accurate with no clerical errors. Mis-matched dates and invoice numbers, for instance, can cause problems that then take time and effort to rectify. Critically, they can delay incoming payments and potentially cause problems with HMRC.

Use the best technology you can afford: the technology best suited to your business may be pricy, but it can reduce costs long term.

Where’s the capital tied up? Understanding how much working capital is locked up in unsold stock, raw materials, etc., is important for your overall cash flow management. Could it be used to raise cash through asset finance to help drive forward your business?

What’s your working capital (i.e. current assets less liabilities)? This is what you need to pay staff wages and pay your suppliers. This figure changes according to the times and seasons.  Careful management is needed to maintain sufficient working capital through the year.

Chase unpaid invoices when they fall due, without undue delay. All businesses expect to have to either chase, or be chased for, unpaid invoices. Dealing with this is vital to maintain a healthy and professional relationship between business and supplier.

Predicting times of drought means you can prepare. Consider alternative sources of finance, such as asset finance, to enable you to get through difficult times.

1 researchbriefings.parliament.uk/ResearchBriefing/Summary/SN06152#fullreport 
2 www.accaglobal.com/content/dam/ACCA_Global/Technical/smb/pi-financial-management-entrepreneurs.pdf