Your approach to managing your cash flow could make or break your business.
Whether you are the owner of a small business, or working as an independent professional, cash flow is of vital importance to the health of your business. It is often said that: “revenue is vanity, cash flow is sanity, but cash is king”. What this means is that whilst it may look good to have large inflows of revenue from sales, the most important focus for your business is cash flow…
Cash comes into your business (cash inflows), mostly through sales of goods or services and flows out (cash outflows) to pay for costs that you must incur in order to produce or provide your goods or services. The difference between the two is called the net cash flow. It is, of course, desirable to maintain a positive cash flow in order to pay your bills on time, and invest in the growth of your business.
Planning gives you the opportunity to ask the right questions of your business and will help you to avoid unnecessary costs, charge the right price, and define appropriate payment terms.
An effective budget and cash flow forecast can mean the difference between business success and failure. A good forecast that allows you to produce alternative scenarios will give you the foundation for sound and timely decision-making.
If you are seeking finance for your business, reliable cash flow information will be essential.
Cash flow problems often catch small business owners by surprise. An accurate cash flow forecast can protect you against this situation. A cash flow forecast charts the amounts of money your business expects to receive and pay out each month in a rolling six- or 12-month period.
Be brutal with your sales forecast
Whilst you must plan for success, it is essential that you also keep an eye on a worst-case scenario that assumes the lowest possible growth in sales revenue. With this in mind you can identify contingencies that will allow you to deal with such an outcome should it occur. Only include firm orders in your short-term sales forecast (next three months), and keep the longer-term forecast as realistic as possible, taking into account historical sales performance, customer retention rates and market conditions.
Be careful not to under-estimate the time it takes for advertising and marketing activity to produce actual sales revenue.
Make sure you account for sales receipts in the month they are likely to be paid, based on the terms you have agreed, not the month they are invoiced. Use historical data to work out average debtor days (how long your customers typically take to pay) and apply this to your sales forecast.
If you are accepting credit card payments, make sure you take account of the effect this will have on when you actually receive payment from your chosen payment processor.
Above all, make sure you can consistently and reliably deliver to the standard your customers expect.
Be thorough with your operating expenses
As with your sales, it is vital to note every expense in the month it will be paid, not the month it is incurred. You should also ensure that you take account of the increase in expenses that will result from higher levels of sales and inflationary rises. Be sure to include the following items in your list of business expenses:
• Gross wages, including anticipated overtime
• Payments of dividends
• Payroll taxes and benefits, including paid holidays, paid sick leave, health insurance, and unemployment insurance
• Subcontracting and outside services, including the cost of labour and materials
• Bank charges, such as account fees, overdraft arrangement fees and annual credit card fees
• Purchases of materials for use in making your product or service, or for resale
• Supplies for use in the business
• Repairs and maintenance
• Packaging, shipping and delivery costs
• Travel, car, and parking costs
• Hotel accommodation and subsistence
• Advertising and promotion, including directory listings, web site maintenance and design
• Professional services such as fees paid to solicitors, accountants, consultants, etc.
• Rent and Rates (or costs for use of a home office if appropriate)
• Telecommunications such as phone, fax, Internet Service Provider
• Utilities such as water, heat, electricity, gas
Interest and Taxation
You will also need to make allowance for payment of interest on overdrafts and loans (and any interest receivable) and payment of your tax liabilities, which will include VAT if you are registered and Corporation Tax, if you are operating through a limited company. It is worth getting help with tax planning from a professionally qualified accountant – as well as optimising your cash flow, it could save you a lot of money.
Make allowance for loan repayments, capital expenditure, and if you are a new business, any start-up costs incurred prior to the first month of operation and paid for over the course of the following year(s). If cash is tight, consider leasing assets rather than buying outright. Or consider alternative methods of finance. Traditional finance tools are often difficult to arrange, costly to administer and, importantly, usually tie up or require pledges of company assets.
You will never be able to anticipate every cost that you might incur, so make provision for a sensible amount of miscellaneous expenses.