In the current climate of economic uncertainty, SMEs need to maintain effective cash management. When looking to achieve the best possible outcome with cash flow, there are several steps to take. We discuss some of the key areas of cash flow management and how to forecast effectively.
Credit Control
Starting with the basics, business owners should undertake the following to maximise cash flow efficiency.
- Develop a credit control policy that sets out the terms of trade, credit limits, collection terms. Create a process to follow up in the event of late payments. Collecting debts once billed is equally important.
- Run credit checks on all new customers. If someone has outstanding debts to other suppliers, it is more likely they will not pay you
- Request payment upfront, especially if you have any doubts regarding the payment history. Always agree on invoice amounts in advance, and don’t be afraid to push for payment when due
Credit Terms
Consider whether creditors are paid too early. Some businesses pay every bill as soon as it arrives on the doormat (or in the inbox) without considering planning for cash flow. If creditors offer credit terms, using them helps preserve cash and reduce the cash flow gap.
Supply Chain Management
Having the basics of good buying in place is a solid starting point for effective supply chain management:
- Agree terms in writing
- Use early settlement discounts
- Check invoices to make sure they were billed as expected
- Beware of contract terms and penalties
- Consider the impact of over-reliance on a key supplier and how non-performance might affect you
Reporting
Reporting procedures are key. If you are not capturing accurate information from the start, you cannot compare expectations and budgets reliably. Cashflow forecasts and budgets enable you to control and pinpoint the location of cash. If you locate and understand your pinch points, you are more likely to manage them.
Three-way forecasting
‘Three-way forecasting’ helps bring together data on your profit, balance sheet and cash flow, combining it into a single model specifically tailored to your business. This provides invaluable insight into your business, including developing a wider picture on the assets and expenditures that may not be captured in your cash flow analysis but appear elsewhere. This links directly into business strategy, allowing:
- Business owners to make informed business decisions
- Future planning to become easier
- Comparison of their actuals with budgets regularly to see why they are potentially underachieving and what they can improve
Create a cash flow forecast, imperative for businesses that want to grow. Three-way forecasting can be used to increase profitability and reduce risk within businesses.
Tips To Create A Three-Way Forecast
- Compare your budget to recent actual results.
- Look at the budget from both sides. Is it realistic or unachievable?
- Do there seem to be any major missing costs?
- Do not forget about expenditure that you may not see on your profit and loss, as some business outgoings do not always appear. For example:
- Loans
- Capital purchases
- Capital repayments
- Prepayments
- Accruals
- VAT movements
- Other types of finance
- Think about your assumptions carefully, do not use a broad-brush approach as you may unintentionally exclude more complex issues:
- Is 20% VAT applied to all purchases and all sales? If not, don’t apply this assumption.
- Are all debtors on sales received within 30 days? Whilst this may be the credit terms that are given to customers, make sure you are accurate in recording how they truly pay you.
- Make sure to review your forecast balance sheet over an appropriate period of time. Check each line carefully over the course of that time to review how realistic your figures are. For example:
- Have trade debtors increased by 100%, whereas sales have only increased by 5%? This suggests the assumptions used are not true of reality.
- Finally, always compare your budgets with actuals on a line-by-line basis in a timely manner. This will ensure you are picking up any issues with spending and income and can address them accordingly.
Planning For Growth
Forecasting for growth is equally important. When a business increases activity and turnover without adequate resources to support it, i.e., overtrading, this can lead to unfulfilled orders, unhappy customers and ultimately cash flow problems. Take some time to consider the amount of funding required to cover increased trading levels. Also, consider how that will be financed – this is an important planning tool to help ensure successful growth. It will also provide a level of confidence to any proposed financier in their lending decision.
Other Areas To Consider
Consider a few other areas like mitigation of tax liabilities covering corporation tax, VAT and PAYE. Good planning at the outset can reduce or change the timing of liabilities to your overall cash flow. Do not overlook schemes such as apprenticeships, grants, and incentives, which generally benefit businesses and help cash flow.
It is important to set up the correct processes to help manage financial planning effectively. Plan ahead for the next year and identify any potential issues that may arise so that action can be taken to avoid any downturns. Effective cash management will help to stabilise your business and ensure you are in the best position to take advantage of any upturn.
Professional Advice
Finally, professional advisers can be an invaluable resource when it comes to understanding the numbers, talking through business aspirations and looking at the detail of the changes (big or small) which may transform the business for the better. Make use of their networks too. They may be able to make an introduction to exactly the right person to bring an aspiration to reality.
If you require more information or advice around cashflow management, contact David Crowe, Senior Manager at Menzies LLP, at [email protected].
Menzies is a top 20 leading firm of accountants, finance and business advisors that operate out of a network of offices across Surrey, Hampshire and London, providing our clients with easy access and local knowledge. Described as the ‘best performing firm outside of the top 10’ by Accountancy Magazine, Menzies has over 400 employees and an annual turnover of more than £40m.
