For many small businesses, good cash flow management can be a constant worry. Juggling payments and invoicing and managing stock can prove to be a headache and even a healthy profit and loss sheet can be undermined by negative cash flow.
Frequently, SME owners find themselves in a time-poor situation, working across many areas of the business, often with minimal levels of staff support. In many cases, it’s financial planning that gets put on the back burner, in favour of tasks often perceived to be more critical to the day-to-day operation of the business.
However, failing to have a robust budget or cash flow forecast in place can be the first sign of potential problems. Without such important management tools in place, businesses can find themselves fumbling in the dark, unable to accurately assess where they want to go and how they’re going to get there.
In terms of fixed costs for running the business, it is likely that some form of budgeting exercise will have been undertaken in the early days of trading. However, failing to recognise how these costs could flex and change in response to market conditions could result in shock further down the line. For example, importers of foreign goods are likely to be acutely aware of the effects of fluctuating currencies or market conditions, however if possible scenarios are not incorporated into budgets and forecasts, it becomes difficult to identify appropriate mitigating steps. These could be price increases or cost reductions, even extending to simply understanding that a reduction in profit is on the horizon.
Being aware of potential risks to cash flow and failing to react can often be attributed to an element of hoping that things will get better. In many cases this is correct – a bumper order may come in or the competitor landscape may shift in their favour. However, taking such an approach is risky and although small business owners and entrepreneurs are by their very nature optimistic, this must be combined with the discipline of understanding how negative events could affect the running of the business.
All small business owners will inevitably face difficult decisions, whether reducing staff overheads, having difficult conversations with suppliers to negotiate discounts, re-tendering for contracts or downsizing premises. Making the move to understand, accept and address these is a brave, but necessary step in heading off cash flow management issues before they become a far more serious problem.
Budgets and forecasts
Generally, there is no hard and fast rule to follow when preparing budgets and cash flow forecasts. The days of receiving the monthly accounts are long gone and the prevalence of cloud-based technology has meant that many businesses are now able to see their financial data in real time. In terms of preparing budgets, the nature of many small businesses means that it’s often hard to look at the next six to 12 months of sales. However, generally it is good practice to have a 12-month rolling forecast in place and to regularly benchmark the businesses against these budgets.
Analysing work in progress (WIP) and debtors is another key element of good cash flow management. So many businesses fall down because they neglect their WIP and do not keep a tight enough grip on their debtors. In the case of many struggling businesses, it may seem that they are in a comfortable, profitable situation, however on closer inspection, many of the debtors who owe money are unable or never likely to pay, resulting in a significant loss of cash flow.
Often this is due to a lack of having a designated employee responsible for credit control and the responsibility lies with the directors in many cases. Many businesses do not regard this as a high enough priority and is often earmarked as a ‘Friday afternoon task’. In the event that regular suppliers or customers are slow with their payments, in addition to a rigid set of payment terms, it would be a wise move to build in a certain amount of cash to act as a buffer, allowing some breathing space for slow payers.
It is now much easier for small businesses to set up direct debit facilities and to take electronic payments as well as setting clients up on a monthly retainer. Even with these tools available, whatever the payments terms are, if a business doesn’t have someone who is proactively chasing unpaid bills it is dangerously easy for time to slip away and the likelihood of problems further down the line increases.
Businesses must be wary of positive cash flow reports and it is an easy mistake to forget about significant outlays that are paid at irregular intervals. This could be VAT, which is usually paid once a quarter, or corporation tax, which is paid nine months after the year end. While things may look healthy from a cash flow perspective, it could still transpire that significant tax liabilities have been forgotten about.
When unexpected expenditure does arise, the temptation for directors to invest their own money or enlist the help of family and friends is often strong. The wage bill might get paid at the end of the month but this is more often than not a sticking plaster; businesses should stand on their own two feet and where possible assess the root problem.
The need to consider large amounts of future expenditure must be combined with a proactive attitude to tackling costs before they spiral out of control. Revisiting the cost bases of the business often strikes fear into the hearts of SMEs, who perceive activity such as renegotiation of contracts as unwieldy tasks.
Despite the struggles often encountered when approaching cash flow management, business owners should not feel that they are alone. Advice is available and business owners must make use of it at the earliest opportunity. Addressing problems at an early stage, whether they are securing an overdraft with the bank or a payment extension with a supplier, acknowledging an issue early on can drastically improve the chances of a financial recovery.
In a business where cash is king, pride sometimes needs to take the backseat to a proactive attitude and a willingness to accept help and advice.
Martin Atkins is a partner and head of business services at Menzies LLP.