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Managing cashflow

Every business has to watch its income, profit and cash situation

Why do I need to forecast my cash flow?

It is essential to know how much money a business will need to meet payments when they are due. A cash flow forecast helps analyse expected receipts and payments and can be used to determine whether there is a need for an overdraft to provide sufficient working capital.

For new businesses, it is particularly useful to be able to determine exactly how much finance will be required to take the business through its early stages and to pinpoint when money will be needed. The cash flow forecast is the key part of any business plan from the point of view of potential funders.

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What information do I need to write a cash flow forecast?

A typical cash flow forecast is split into three sections: receipts (all monies coming into your business from sales, loans, etc); payments (for expenses, loan repayments, drawings, etc); and balances (a monthly balance and a cumulative balance - which should be equal to the cash in your bank account).

A cash flow forecast only shows cash in and out, so non-cash items like depreciation are not included.

In order to prepare a forecast you will need to prepare budgets for sales and expenditure. From these, you can estimate when you expect to receive money for your sales (unless you are in a cash business, like retail, you will provide customers with an invoice and expect to wait some weeks before you are paid). You can also estimate when you might have to pay for the expenses that you incur - for staff wages, rent, insurance, advertising, bank charges, interest, raw materials, etc. You should also include loan repayments, your own drawings or salary and VAT if applicable.

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How do I ensure that I can meet my expenses?

A cash flow forecast gives you a basis for predicting your receipts and payments and thus ensuring that you have enough money to cover the payments as they fall due. If you do not have enough money to put into the business, and you have to wait for receipts to start flowing, then you will need some additional working capital - often provided by the banks in the form of an agreed overdraft.

One of the most important forms of finance for a business is creditor finance - that is, paying your own creditors as late as you can reasonably manage. The longer you delay paying them, the smaller your overdraft. However, if you delay too long, they will not be impressed and may even stop supplying you.

If you have longer term finance needs (for the purchase of capital equipment, for example) then you may also need a term loan. As an alternative, you may be able to secure so-called asset finance - as a lease or hire purchase arrangement.

Once you are established and have built up a track record, you can speed up the payment of your invoices by using factoring or invoice discounting. However, these are relatively expensive options and are not worthwhile until your business starts to grow.

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How can I get customers to pay quicker?

There are many ways to ensure prompt payment and most of them have to do with good planning and communication with your customers. Here are some guidelines:

  • Check the creditworthiness of your customers before you start to offer them credit.
  • Agree payment methods and terms prior to allowing credit.
  • Use a written contract to set out your trading terms - and if you provide goods, include a 'retention' clause so that ownership does not pass to your customer until you have been paid.
  • Send out your invoices so that your customers receive them before the end of the month - which should mean that you get paid at the end of the following month.
  • Ensure that invoices are correct.
  • Keep in close touch with your customers while waiting for payment.
  • Monitor overdue invoices closely and contact customers regularly about late payments.
  • Stop deliveries to customers if they exceed their credit limit or fail to pay within the agreed timescale.
  • You might also offer discounts for prompt payment - but watch for the customer who pays late and also tries to take discount. Remember to build discount into your costing and pricing.

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What can I do if I run out of cash?

It is not easy to raise additional cash at short notice or in a crisis, so cash flow problems are usually shouldered in the first instance by a business' suppliers. However, they can cause difficulties by making a statutory demand for payment or by starting bankruptcy proceedings. Ideally, you will be monitoring your cash position carefully; if it looks like you may have a problem, talk to your bank at an early stage about increasing the level of your overdraft. If you do find yourself short of cash, reassure your suppliers and work hard to get in the money owed to you so that you can pay your suppliers.

  • Talk to your bank about your overdraft arrangements.
  • Talk to your suppliers and reassure them that they will be paid shortly - if necessary, agree a payment schedule with them and pay over a number of months.
  • Check that you have invoiced all of your own customers - and offer an incentive to pay early.
  • Review all of your costs and cut down your expenditure as much as you can.

If the problem looks insurmountable, talk to your accountant or other professional adviser. It is an offence to continue to trade once you know that you are insolvent - once you know that you cannot pay your debts as they fall due.

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Hints and tips

  • When you prepare your cash flow forecast, you should also undertake a 'what-if' analysis. What happens if sales are 10% less than forecast? What happens if raw materials increase in price by 20%? You can then forecast the worst-case finance requirement - which mitigates the need to go back to your finance sources for more cash.
  • Invoice your customers promptly and accurately - and follow up to check that they have paid.
  • Review your actual cash flow regularly - at least every month. Check that it is line with your forecast and act quickly if it is not.

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