Effective cashflow management

Finance and accounting
Managing Cash Flow

Cash is the essential lifeblood of any business.  Chris Thomas, Finance Director at SME Finance Partners, gives his top tips on how businesses can effectively manage cash flow.


The importance of cash management 

Without cash no business can operate successfully. Lots of business owners say “I’m profitable but I can’t see that in the bank”. This is where an understanding of cashflow becomes important, as profit isn’t the same as cash. 

With a challenging economic environment of high inflation, rising interest rates, low growth and a hangover of Covid debt, effective cash management is essential in navigating uncertain times.

So, what comprises effective cash management?  Essentially it means that a business has sufficient cash to operate normally without distress, that cash is generated from sales enabling suppliers, employees, HMRC and loans to all be paid on time, and the business has good visibility over cash headroom for the foreseeable future.


Tips for effective cash flow management

Profit vs cash

Generating a profit and generating cash are different things. Profitable businesses don’t necessarily generate cash, and even profitable businesses can run out of cash. Cash outflows such as loan repayments and capital expenditure are not profit and loss expenses and can have a big impact on cash flow.  If a business has significant debt (loans) then it has to make sufficient profits to enable the business to repay these loans, and if it doesn’t then it’s likely to suffer cash pressures. It’s important to understand and quantify what your annual debt repayments are (referred to as debt service costs), and plan or budget to make profits that comfortably cover and repay that level of debt.

Likewise, working capital (debtors, stock and creditors) has a significant impact on cash.  If your customers pay you on average in 60 days, but you have to pay your suppliers in 30 days, then there is a constant working capital shortfall that needs to be funded.

Understand your cash position

A business owner will know whether they are feeling cash pressure, but an easy way to assess this would be to look at your annual operating cash costs (payroll, rent, rates, insurance, overheads, loan repayments) from your annual accounts, and divide this by 12 months to understand your average monthly operating cash cost.  Comparing that with the average bank balance over the last 12 months will tell you how much “cash cover” you have. 

Ideally, that would be three months’ worth of cover, providing a comfortable level of cash headroom. Anything above three months’ cover would be considered to be in a strong cash position; anything below three months’ cash cover and cash is tighter.   Every business is different, and smaller lifestyle businesses might not need so much cash headroom, but the majority of SME, owner managed businesses that we see in Wales fall into the category where cash can be tight, requiring an increased focus on cash management because any unexpected changes could create cash pressures. 

Forecast your cash

If cash is tight then a simple forecast will provide visibility over potential cash “pinch points”, avoiding any nasty surprises and enabling corrective action to be taken in time.  A weekly rolling cash forecast for the next 13 weeks is essential as this will capture more “lumpy” payments such as large supplier payments, Capital expenditure, and quarterly VAT or rent.  A cash forecast will show your opening bank balance, and by week estimate cash coming in and cash going out for payroll, supplier payments, direct debits etc., to give you a forecast weekly closing bank balance. 

Forecasting cash might sound difficult, but it’s pretty straightforward. A simple spreadsheet often works well, and if the company hasn’t done one before then an advisor or accountant could quickly support with this.  Costs can be forecast with some certainty, as items like rent, rates, insurance, direct debits and loan repayments are predictable, while payroll can be estimated based on historic averages.  Sales can be more difficult to forecast, and if there is no certainty on these then using reasonable assumptions based on historic trading will do the trick.  Once it’s set up it should be kept up to date on a weekly basis, and having something down in black and white helps to give increased visibility and avoid any nasty surprises.

Strong credit control

Make sure that you get paid on time for the work you’ve done! Get your invoices sent out quickly and efficiently without delay to keep the cash coming in.  Modern cloud accounting systems such as Xero, Quickbooks and SAGE Cloud enable you to send invoices electronically, helping to speed up the process of invoicing.  These systems can also be used to send automated reminders and statements to customers if invoices become overdue, helping to ensure that they get paid.  If customers don’t pay on time, don’t leave it too long before it gets chased up as the longer it goes on the harder it becomes to collect.

If invoices become seriously overdue, then have an escalation policy that you stick to whereby you send a final reminder.  Chasing debt can be uncomfortable, but it’s your money, and unless you chase you risk going without.  If after taking all reasonable measures you remain unpaid, then consider engaging a debt recovery firm who deal with this day to day and often get good results.

Review working capital and asset utilisation

All business have cash tied up in different assets, including fixed assets, stock and trade debtors.  But you can’t use stock or debtors to pay the payroll, so converting these assets into cash is essential. 

Review the rate at which stock is converted into sales and look to sell any slow moving or redundant stock.  See if suppliers can hold consignment stock which you can access but don’t have to pay for unless or until it’s used. 

Some businesses are “asset intensive” with substantial value tied up in plant, machinery and vehicles.  If cash is tight then asset utilisation should be reviewed to make sure that these assets are being fully used. 

Get the right funding structure

Every business is different and so the right funding structure will vary from business to business.  There are so many different types of funding: debt (loans), equity (investment), invoice finance (debtor finance), supplier finance (creditor finance), hire purchase (asset finance). It’s a real minefield, and getting the right professional advice will help in ensuring the right funding structure is put in place to properly fund the business. 

Use your management information

Ensuring that the business has regular, up to date and accurate management information (MI) is the best way of measuring business performance and making sure that you remain “on track”.  Up-to-date MI and Key Performance Indicators (KPI’s) act as early warning signals that performance might be dipping.

Ideally, having an annual forecast or budget against which performance can be tracked is a good discipline for most businesses.  Having good MI and a robust financial forecast are key requirements that banks will ask for and require when a business is seeking funding, but they are great tools for management to help improve business performance to ensure that the business has robust cashflow. 

Review your Terms and Conditions

When did you last review your T’s & C’s?  If the payment terms that you offer customers are more generous than the credit terms you receive from suppliers, then the difference in payment terms needs to be funded.  If changing these is too challenging, then a work around might be needed.  Look at whether you can improve credit terms from suppliers or consider whether offering customers a small discount for earlier payment is an option.  If terms can’t be changed, then get advice on putting the right working capital facilities in place to support the business. For certain businesses that have to offer customers credit terms, then an invoice discount facility can work well where you can drawdown a percentage of the invoice straight away, with the balance being available when the customer pays. 


Case study

SME Finance Partners recently worked with a growing specialist bulk liquid haulage business that had grown rapidly, taken on significant debt and was under constant cash pressure. 

Our first priority was to understand their cash position, and from reviewing recent bank statements we could see that cash was extremely tight. Next, we needed to understand what was causing this pressure, and we quickly highlighted that the level of monthly debt repayments on hire purchase (asset finance) was too high.  When we dug a little deeper, the business had invested heavily in some assets that were only used seasonally, were less than 25% utilised and the business was losing cash each month on these assets which came as a surprise to the business owner. 

We prepared a detailed weekly cash forecast for the next three months, highlighting that cash would be very tight and would need to be carefully managed.  In the short term, overdue debtors were chased down and the accounting software was used to tighten up credit control.

Longer term, integrated financial forecasts were produced which showed that with the right actions, including selling surplus equipment, the business could get back on track, but that support was needed along the way.  We approached the Development Bank of Wales who supported with a loan of £200,000, giving the business the breathing space to implement its plan.

Within six months, the unprofitable assets had been sold, debt had been reduced and monthly debt commitments fell significantly, easing cash pressures.  Since then, the business has re-focused its efforts on its more profitable workstreams, and having successfully grown these it is generating strong cash flows which are reflected in a much healthier bank balance.

What's next?

To find out more about cash flow management and financing options, get in touch with your Portfolio Executive at the Development Bank of Wales. 

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