By Simon Paterson, Partner at Surrey accountants, RJP LLP
Managing cash flow is one of the biggest challenges a small business owner has to overcome. It is the reason why many sound businesses often fail. They have a fantastic product or service, but cash flow problems and an inability to raise the finance they need in the short term can mean they cannot meet their liabilities and hence they fail. According to recent US research, it is the reason why 82% of small companies fail.
Understanding how to manage cash flow effectively and keep things running smoothly is absolutely essential for every business owner, whether you are a sole trader, partnership or limited company. Here are 6 common challenges a company can face when it comes to managing their cash flow with practical advice on how to overcome them.
- Paying staff salaries on a weekly basis
In some industries, it is considered the norm to pay staff on a weekly or fortnightly basis. This is common in the construction and hospitality industries but the downside is it results in cash having to be found on a weekly basis, which means a constant drain to cash flow levels. It is especially problematic when staff are being paid weekly and yet customers are on 30 days or more payment terms. Moving staff to monthly payments will ease the cash flow burden.
- Poor credit control function results in customers paying too slowly
Customers paying too slowly is a big reason why businesses can struggle with cash flow. Having a good credit control function in place, which ensures that income is received on a regular basis and within credit terms, is absolutely essential. Consider having a dedicated person to take care of credit control or outsource it to a specialist.
Start off by making sure the customer gets the invoice in the first place, so there are no excuses. Then follow up again just before the invoice due date, to ensure that if there are potentially going to be delays, you can plan ahead for them. In the majority of cases, if customers know you expect prompt payment as the norm, they will get into good habits from the outset.
- Over trading of the company
Whilst increasing turnover is important, it should not be to the detriment of cash flow. In many instances a business will chase turnover but if the business is incurring costs up front and payment is not received until a significant period after then the bigger the turnover gets then the bigger the cash flow deficit will become. Where possible try and get out of pocket expenses paid at the start of a project.
When growing a business you need to plan ahead and ensure you have access to cash flow boosting facilities such as a bank overdraft. Another good option is to use invoice discounting facilities, which allows you to draw down on revenues due to you in advance of being paid by the customer.
If you need to hold stock within your business then you make look to a stock finance facility which again can improve the cash position of the business whilst at the same time holding the stock.
- Buying capital equipment outright unnecessarily
It can be tempting to buy assets outright if you happen to have the funds available at the time. However, it is not always wise and may be more beneficial to use a funding facility such as hire purchase or bank loan. For instance, if you are looking to buy computer equipment for your business it can be a hefty one off outlay. Spreading the payments over 2-3 years will greatly assist the cash position of the company.
- Minimise expenses and overheads
Where possible, try and keep fixed overheads to a minimum. This then gives you flexibility as you grow and means you can adapt to a changing market. For example use outsourced services for HR, accounting etc. rather than having dedicated staff which is then a fixed cost you are committed to. Having costs which are of a more variable nature means you can dip in and out of them as you need them.
- Under-pricing for your products and services
When you first start out in business or in order to attract a client, it can be tempting to under price for a job or service. Short term, it might be helpful to secure some business but this creates problems in the longer term. For starters, it means your client will get used to paying less and it makes it harder to increase prices later on. It also devalues what you do, the client may be less likely to really appreciate the work because they see you as a ‘cheap supplier’, and it can create resentment in the long term.
It is far better to price yourself accurately and if the customer is unwilling to pay, walk away. If you quote a fair price it is probable they won’t get better elsewhere and are likely to realise this and return. And from a cash flow point of view, under-pricing means lower profits and the lower the levels of cash you will ultimately generate.
Cash flow is the lifeblood of a business but it is a balancing act. The trick to managing cash flow well is to take a multi-pronged approach and seek improvements to a range of different things. Work on the principle of marginal gains. Small improvements made consistently will result in a big improvement over time, and you won’t look back.