Q&A: Cash flow management

Chartered Accountant Howard Hackney talks about the steps you need to take to ensure your cash flow remains healthy

Why do I need to have enough cash in my business?

The old saying 'turnover is vanity, profit sanity and cash reality' remains true. Businesses go bust in the long term through lack of profit, but in the short term, they fail because they don't have enough cash to pay their bills. Cash flow is the blood supply of any business.

But what is cash flow?

cash flow describes the relationship between money entering and leaving a business. Obviously, you need more coming in than going out, but it must also come in on time, otherwise you won't be able to pay your overheads. Such developments are called 'cash flow crises'. If you can anticipate them with good cash flow management, you might be able to arrange an overdraft extension or bank loan to get you through.

I anticipate good turnover and healthy margins – surely I'll be OK?

Not necessarily. Firstly, you must establish what margin you'll be making on your turnover, because the business' gross profit [turnover minus direct expenses] is the real figure you should focus upon. Secondly, you must make enough gross profit to cover your overheads. This figure is called your breakeven – and you need to know what it is.

What's the worst that can happen if I fail to control my cash flow?

You go bust. Lack of positive cash flow and sufficient funds to finance the business is the most common reason businesses fail. If you're a limited company, you will have personal liability protection for debts incurred, providing you have administered the business legally and you haven't personally guaranteed loans. However, sole traders risk personal bankruptcy.

How can a cash flow forecast help my business?

The old adage "what gets measured gets done" is true of forecasting. Unless you forecast, you're unlikely to control your cash and business properly. You need to know how much you need and when you need it. If you seek a loan, your bank will request a detailed integrated cash flow forecast before even considering your application.

What key credit control measures do you recommend?

Unless you're a cash business or very lucky, you need to stay on top of your debtors. Effective credit control is all about getting paid as soon as possible – or at least on time. You must remain aware of how much money you're owed and when the debts became due. Each month, find the average number of days' turnover you're owed by debtors. If this is more than 60 days, you should be very worried. You must set credit limits and terms, understand your customers' payment processes, get your invoices out on time, resolve all disputes quickly and chase all debts rigorously when due.

How important is it that I remain aware of my cash position?

Vital. If you don't know how much you have in the bank and how much you owe and are owed, you're not in control of your business.

When and how should I pursue overdue payments?

The longer a debt is outstanding, the less likely you'll get paid. Firstly, find out why you haven't been paid – has your invoice simply been mislaid? Perhaps it's more serious… maybe a customer is claiming your goods were faulty. Maybe – even more worrying – they cannot afford to pay. Otherwise, telephone reminders are effective if you speak to the right person. Get a promise on when you'll be paid.

Can I raise finance against unpaid invoices?

Depends on your type of business and your debtor's creditworthiness, but it's possible. This is called trade finance and comes in two forms – factoring, where you sell debts to the funder and your debtors pay them directly; or confidential invoice discounting, where debtors are unaware of the funder and continues to pay you.

Should I go to court to pursue unpaid debt?

Always a last resort – and never threaten it unless you intend to follow through. You should include in your terms a 'Reservation of Title' clause, which allows you to recover goods if you're not paid.

What are the classic signs of cash flow problems?

Continually bumping up against your overdraft limit and being chased for payment by your suppliers. Never assume cash flow problems will go away if you ignore them. They must be addressed. The actions you need to take will depend on the size of your cash flow problems. If you're still profitable, you might just have to tighten up your credit control measures, reduce your costs or perhaps seek assistance from the bank. More serious and regular cash flow crises will require more drastic action. If you continually face considerable cash flow problems, then one day your luck is likely to run out.

Written with expert input from Howard Hackney.

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