Managing cash flow effectively is a core discipline for your organisation. Businesses that manage cash, wealth and capital well tend to be more profitable in the long run – coping better with economic cycles, building greater resilience, and ultimately enjoying more success.

You can be a profitable business, but if your cash flow is not well managed you could find yourself struggling to pay for what you need to keep going. For small businesses it is a good discipline to get into from the start, as it reduces stress, helps you plan for the future, and shows your lenders and advisers that you have control over your business.

1. Start with good cash flow forecasting

Accurate cash flow forecasting can mean the difference between staying in business or going bust. Understanding your cash flow will help you see whether you have enough money coming in to allow you to pay your bills.

A straightforward way to manage day-to-day cash flow is through a simple receipts and payments cash flow forecast says Martin Flint, Director of Working Capital Advisory at Lloyds Bank Commercial Bank.

In this type of account, he explains, the top half of the forecast is the cash you think you're getting in, and the bottom half is what you're going to pay out – to suppliers, tax, payroll, rent, etc. And then you have a balance at the bottom. Normally a receipt and payment account is done over a weekly basis, looking forward to the next three months.

If you update the forecast on a weekly basis, you end up with a rolling 13 week forecast – but the outlook could be longer if that is more useful for your business. You’ll also need to keep your books up to date, as you’ll rely on this information for your cash flow forecast. In particular, your sales ledger (e.g. list of customers and outstanding invoices) and purchase ledger (e.g. list of suppliers and what invoices you need to pay).

reaching for calculator

In order to forecast cash over a three-month period, you will also need to predict future spending on things like raw materials or equipment, alongside more regular employment and premises costs. In an ideal world, you would have an accurate view of the demand for your products and services over the forecast period. This will help determine what raw materials you need to buy and when in order to make those sales to achieve customer delivery timeframes.

Where sales forecasts are over-optimistic and actual sales are lower, you will end up holding much more stock, which ties up additional cash in working capital. Your cash flow forecast should enable you to see how much cash you have over the forecast period, allowing you to identify and plan for potential short-term funding gaps.

If your business is bigger than just you, make sure you involve the key members of your team in creating the forecast. They need to understand its importance and feel accountable for their predictions, so that they input accurate information.

How frequently you update your forecast will depend on:

  • Your forecast accuracy
  • Cash flow fluidity
  • How much your business plans rely on positive cash flow.

2. Plan for different scenarios and understand the challenges of your industry

Once you have your longer-term forecast in place, it is worth scenario planning to see the effect of potential impacts on your cash flow situation. For example, what would happen if:

  • the cost of a key raw material or postage and delivery rose by 10%?
  • oil prices suddenly increased and affected transportation costs?
  • a potential downturn negatively impacts sales by 5% or 10%?
  • payments are delayed as customers tighten their belts?
  • there is a sudden unforeseen expense, such as an increase in National Insurance announced in the Budget or changes in regulations?

You could find yourself with fewer sales and higher costs. All of these considerations will alert you to potential pinch points and allow you to make tactical adjustments to manage your cash flow.

Different industries have different cash flow issues, for example:

  • a solicitor or accountant won't have stock, but will have people and property costs against the outstanding amounts on customer bills
  • a tradesperson might not get paid until the whole job is completed, but has to pay for raw materials or parts up front
  • a manufacturing company with raw materials and stock has to carefully align production and demand
  • a clothing retailer, where customer card payments may clear within a couple of days, but sourcing garments from abroad means dealing with fluctuating currency and long payment terms

You need to understand the advantages and difficulties of your own industry to help you focus on the right issues. It is worth considering looking at benchmarking your company against competitors to see who's getting cash in much sooner. You can get a rough estimate from a simple analysis of financial statements. It will help you work out if you are an outlier within the sector, and start to question why and what you can do to improve your position.

3. Consider your one-day cash flow value

A tip from Martin Flint is to think about the value of just one day of cash flow, to help you understand its importance. He suggests you work out what would happen if you:

  • were able to collect your receivables one day quicker
  • are unable to get rid of your stock until one day later
  • pay your suppliers one day later.

Understanding the impact on your business for each of these scenarios can then help you to think about the trade-off between cash flow and profit. For example, when you're talking to customers or suppliers and negotiating deals.

If you’re interested in growing sales and making your offer potentially more appealing for customers by offering looser credit terms, you need to know what the impact will be on your business. What would happen if the customer asks to pay in 45 days rather than 30 days? Understanding the impact of just one day will help you assess the effect of delayed payment by 15 days on your cash flow.

4. Provide cash flow training for your team

Once you know the value of one day in cash flow, you can train your teams so that they understand the full effect of its impact in any negotiations around contract terms. More and more businesses are trying to hold onto their cash for longer, which can be a challenge.

Make sure everyone involved in negotiations with buyers and suppliers understands the issues, so they know where they can go safely when discussing terms, without having a negative impact on your cash flow. For example, with large orders or long-term contracts you might want to phase payments rather than have one large payment at the end.

Training can also help your team realise the value of accurate input to forecasts, and why they may need to alert you and other colleagues to the situation when things change, for example:

  • a long delay on an anticipated contract
  • changes to volumes or payment terms
  • if a customer is indicating that they are going to cut back on or cancel the business they do with you.

You and anyone else involved in buying what your company needs should understand:

  • Why a special offer bulk buy, although a bargain, can tie up cash for a long time that could be better used for something else.
  • Why closer matching of purchasing to output can positively impact cash flow.
  • When to ask for longer payment terms on purchases, and when lower costs and shorter terms are more valuable.
  • Why they need to keep control of costs to stay within budget and cannot spend without good reason.
  • Why unforeseen expenses must be avoided.

5. Communicate effectively within your business

Sales and operations planning processes have to work well together to achieve full visibility of demand. Raw materials need to be ready and available to meet production needs, stock needs to be there ready to sell, staffing levels need to be able to meet customer demands. This is potentially easier in smaller companies, but as your business grows you need to make sure people aren’t working in isolation, based on out of date information.

This is particularly true for the finance team or individual accountant who may be responsible for preparing a cash flow forecast. Ideally when preparing the cash flow forecast, you need to go and speak to the people that understand most about each particular cash inflow and outflow.

group looking at computer screen

But also, in retrospect you need to review forecasts for a particular period and compare how accurate that forecast was to the actual numbers your business achieved within its cash flow, explains Martin Flint. This will help your forecasting improve in the future. Where there were differences, you need to go back and discuss with those responsibilities for sales or procurement:

  • What happened to cause the differences?
  • Can it be avoided in future?
  • How can this information be fed into the forecast in future to keep it on track?

It can also help flag things that the business may need to deal with – for example:

  • if a particular person or team is consistently inaccurate about their cash flow figures
  • if there are issues or behaviours associated with a particular company or customer that affect cash flow.

Good communication can help sensitise your colleagues to issues that can impact the cash flow forecast. It also allows you to come up with effective tactics to deal with issues, improve the accuracy of any forecasts, and speed up the process of passing on information that alerts you to potential problems too.

6. Make sure you get paid promptly

Communication isn't just an internal issue, it can also help to reduce payment delays, says Martin Flint. This can matter especially when you are a small company dealing with much larger corporations.

  • Credit check new customers before you take them on, and if in doubt get them to pay in advance
  • Make sure invoices have all the correct information on them to ensure smooth payment
  • Issue invoices promptly
  • Ensure your customers pay up as close to contract terms as possible - there is nothing wrong with expecting them to stick to the terms
  • Have a defined escalation process around late payments, only allowing for flexibility in particular circumstances

It can be worth a call in advance of issuing an invoice to make sure you include all the necessary information and resolve any potential challenges. It's about just being proactive and it is good customer service anyway, says Martin Flint. “If customers are happy with the products and happy with the invoice and the service, then there's potential for repeat business,” he adds.

Consider how you want to deal with the different customer approaches to paying:

  • Some businesses have a set payment frequency, weekly or fortnightly, which means for example, if an invoice is received on a Monday and the business’ payment run is on a Friday, it will always pay things potentially up to four days late.
  • If particular customers are always paying late, you need to find out what the problem is and work out how to deal with it. Is it because they have issues and you could get left with a nasty debt if they go out of business?
  • Even if customers are paying you on time but have imposed long payment terms in their contract, do you need to change the price that you charge them to reflect the additional funding costs from the delays?

There may also be disputes that need to be resolved before an invoice can be paid, so you need to be on top of them. Which leads on to the next point.

Enforcing payment terms for customers and suppliers may feel uncomfortable at first, but it’s simply good business practice, and good suppliers and customers – as fellow businesses – will understand your situation.

7. Manage with proper oversight

Businesses should look at their own management information to discover trends and see what their own cash flow is doing over time. Are you continually racking up late payment charges because your own business is not paying promptly? If you’ve offered discounts for prompt payments, have the conditions actually been met? If you are trying to reduce costs, are you hitting your targets and was the forecast correct?

If you're in a healthy cash position, and it's getting better, then everything is working well. But if it's not, and you find you've got more and more challenges to face on a regular basis, you might need to start making some changes.

Martin Flint says:

"You want a regular drumbeat of meetings and management information that will look at cash and working capital, including cash flow forecasts. It will look at overdue debts, it will look at what's happening with payables, it would look at what's happening with payment terms and credit terms, and how much stock is held by the business."

Improvements to management information systems can help with extracting information, including:

  • which things are overdue and what needs raising as an issue with customers
  • how quickly customers pay
  • how quickly you pay suppliers.

If you are trading profitably and still have cash flow challenges, you need to closely examine how quickly you are getting paid and how quickly you are paying your suppliers. If it is taking you longer to get money from your customers than to pay your suppliers, you will need to find ways to resolve this imbalance.

Make sure you understand your cash conversion cycle, says Martin Flint. This is the average time you have cash tied up in your business. That includes:

  • the average time your customers pay
  • the average time you have stock in warehouses and on shelves
  • the average time you pay your suppliers.

Martin Flint says businesses should keep a watchful eye on this figure and see how it is changing. So for example, if the average time it takes customers to pay is getting longer, you're paying your suppliers more quickly, and you are holding inventory for longer, you will be able to see that overall the situation is getting worse and decide what you are going to do about it.

Making sure that the right kind of information is easily available and digestible can be helped by using reporting and data visualisation software tools, says Martin Flint. These can enable you to quickly dive from the overall business down to invoice level detail.

As you click through, all the graphs and tables update in real-time, so you can get an almost instantaneous response – rather than downloading all the information to Excel, manipulating it, cleaning it, and then trying to present it in a way that gives you the answer you want. A lot of that now can be done directly for you within these programs.

8. Be aware of additional risks with overseas business

Having customers overseas may mean there is potentially a higher risk of non-payment. So you may need to get into the detail of your arrangements and understand what is being done to mitigate potential risks. You may need to consider:

  • potential currency risks
  • ways you work with overseas companies, for example using agents
  • additional costs incurred, such as shipping and insurance
  • differences in contract terms, which result in a different cash flow cycle to your local market.

If you are buying from overseas, you need to get into the detail of payment terms as you may need to pay invoices sooner.

You may need to factor in different dynamics for each of the different markets you are working with, says Martin Flint.

But don’t forget, this can also work in your favour; different markets potentially having different business cycles, bringing in income at different points in the calendar from your existing customer base.

9. Put the right finance options and funding liquidity in place

If your business is seasonal or your cash flow is unsteady – for example you are a wholesaler who does most business around Christmas, or you need to buy an expensive piece of equipment – you should think about the best ways of financing.

For example, if you need to collect cash from your customers more quickly, Invoice Finance might be a good option. Invoice Finance, including Invoice Discounting and Factoring, makes available to you an advance of up to 90% of the value of your invoices, typically within 24 hours. Once your customers pay their invoices, the remaining 10% is paid to you, minus fees.

This means Invoice Finance can allow a small business more flexibility with their cash flow, and the earlier access to cash can be used to support business plans, whether that’s to grow, consolidate or develop a new product. Don’t forget, you will also need to factor in the costs of borrowing to future cash flow.

Your cash flow forecast will help you predict when you may have a cash shortfall. It is always better to discuss these kinds of options with a funding provider in advance of getting into real cash flow difficulties. Going in early with the cash flow needs of your business gives you much more choice to discuss flexible financing options that can meet your potential needs and cash flow challenges.

Many start-up owners struggle to find the time to lift their heads up from the day-to-day pressures of running a business and don’t find the time to think more strategically about the impact of funding on their growth until the situation becomes urgent. But if you are to have all the information you need to help you make well-informed decisions about the business, it’s vital to step back and take in the bigger picture from time to time too.

Don’t forget you should also be putting available surplus cash into interest-earning accounts to generate extra income. Talk to your bank to find the best option available.

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