Kraken Business

Cashflow management: the basics

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Team Kraken

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Managing your cashflow is vital for business survival and growth. To run your business effectively, you need to balance the timing and amount of your costs with those of your income.

This guide explains the various areas you need to consider when managing and improving cashflow in your business, including dealing with customers, suppliers and stakeholders, and using a cashflow forecast to plan your spending and assess potential risks in your cashflow.

Table of Contents

How to measure cash in your business

Every business needs cash available in order to pay their bills and expenses on time, so it is important to balance the timing and amount of money flowing into and out of your business each week and month.

‘Cash’ is the amount of money available to your business – including coins, notes, money in your bank account, any unused overdraft facility and foreign currency and deposits that can be quickly converted into your currency.

Cash does not include any money or value owned by the business that cannot be accessed quickly – eg long-term deposits that cannot be quickly withdrawn, money owed to your business by customers, stock or assets.

In order to make a profit, most businesses have to produce and deliver goods or services to their customers before being paid. So it is essential to control your cashflow so that you always have enough cash available to pay your staff and suppliers before receiving payment from your customers. If not, you’ll be unable to meet your customers’ requirements or receive any profit.

It is important not to confuse your ‘cash balances’ with profit. Profit is the difference between the total amount your business earns and all of its costs, usually assessed over a year or a specified trading period. You may forecast a good profit for the year, yet still face times when you are strapped for cash. For more information, see our guide on how to identify potential cashflow problems.

However, having a lot of cash in your bank account may not always be the best thing for your business. If you have a lot of spare cash available, it can sometimes be a good idea to move it to another account with a higher interest rate, or use it as capital for short-term investments. Choosing the right bank account/s for your business is very important, so it is recommended that you seek professional advice from your bank, accountant or financial adviser.

For more information, see our guide on how to choose and manage a business bank account.

How to measure and improve your cashflow

Ideally, you will have more money flowing into the business than out. This will allow you to build up cash balances to deal with short-term costs – such as bills or expenses – as well as funding growth and reassuring lenders and investors about the health of your business.

However, income and expenditure cashflows rarely occur together – cash inflows often lag behind, so it is important to maintain enough cash in your business to deal with day-to-day running costs. Your aim should be to speed up the inflows and slow down the outflows wherever possible.

Cash inflows include:

  • payment for goods or services from your customers
  • receipt of a bank loan or increased loans or overdrafts
  • interest on savings and investments
  • shareholder investments

Cash outflows include:

  • purchase of stock, raw materials or tools
  • wages, rents and daily operating expenses
  • purchase of fixed assets – PCs, machinery, office furniture, etc.
  • loan repayments
  • dividend payments
  • Income tax, Corporation Tax, VAT, National Insurance contributions, etc

Many of your regular cash outflows will need to be made on fixed dates. So you must always be in a position to meet these payments in order to avoid large fines or a disgruntled workforce.

Improving your cashflow

To improve everyday cashflow you could:

You can also improve your cashflow by borrowing money, or investing more money into the business. This can help you cope with short-term cash problems or fund short-term growth, but it is important not to rely on these in your cash strategy. For more information, see our guide to managing a business when economic conditions are tough.

Cashflow forecasts

Cashflow forecasting enables you to predict peaks and troughs in your cash balance. It helps you to plan how much and when to borrow and how much available cash you’re likely to have at a given time. Many banks require cashflow forecasts before considering a loan.

Elements of a cashflow forecast

The cashflow forecast identifies the sources and amounts of cash coming into your business and the destinations and amounts of cash going out over a given period. There are normally two columns, listing forecast and actual amounts respectively.

The forecast is usually done for a year or quarter in advance and divided into weeks or months. In extremely difficult cashflow situations, a daily cashflow forecast might be useful. It is best to pick periods during which most of your fixed costs – such as salaries – go out. The forecast should list:

  • receipts – any money that will come in during that period
  • payments – any money that will go out during that period
  • excess of receipts over payments – with negative figures shown in brackets
  • bank balance at the start of the period
  • bank balance at the end of the period

It is important to be realistic in your forecast – see our guide on how to forecast and plan your sales.

You could separate cashflow for business operations from funding cashflow. This will give you a clearer picture of the actual performance of your business, by allowing you to gauge how self-sufficient the day-to-day working of your business is. A net outflow in operational cashflow is usually an indicator of problems that need to be addressed quickly.

If you have an established business, it is often a good idea to base your sales prediction on the same period 12 months earlier.

Download our sample cashflow projection spreadsheet [opens in a new window].

Note that all forecast figures must relate to sums that are due to be collected and paid out, not invoices actually sent and received. The forecast will also need adjusting in line with long-term changes to actual performance or market trends.

Accounting software can help you prepare your cashflow forecast, allowing you to update your projections if there’s a change in market trends or your business. For more information, see our guide on accounting software.

Manage your income and expenditure

Effective cashflow management is critical to business survival. It is therefore important to reduce the time gap between expenditure and receipt of income to ensure you always have the necessary cash to pay for your day-to-day business costs.

Customer management

Ensuring your customers pay you on time and in full is vital to maintaining healthy cashflow. To aid this, you should:

Supplier management

You could ask your suppliers for extended credit terms. Giving your suppliers incentives such as large or regular orders may help, but make sure you have a market for the orders you’re placing. Alternatively, you could consider reducing stock levels and using just-in-time systems – see our guide on manufacturing innovation.

For more information, see our guides on stock control and inventory and how to manage your suppliers.

Taxation

As a business, you may be liable for several taxes including Income Tax, Corporation Tax, VAT, business rates and stamp duty. It is important to keep good records to help you calculate your liability and complete your returns accurately. See our guide on how to set up a basic record-keeping system.

If you are registered for VAT, it makes sense to buy major items at the end rather than the start of a VAT period. This can often improve your cashflow, because you can offset the VAT on the purchase against the VAT you charge on sales. This may help you to manage a temporary cashflow gap.

If you are concerned that you may not be able to pay amounts that are owed or will soon be owed to HM Revenue & Customs (HMRC), you can contact the HMRC Business Payment Support Service Helpline on Tel 0845 302 1435. HMRC staff will review your situation and discuss temporary payment arrangements tailored to your business’ circumstances.

Asset management

You could also consider leasing fixed assets – eg equipment – or buying them on hire purchase. Buying assets outright can place a huge drain on cash in the early years of business, so it can sometimes be more cost-effective to lease them instead. See our guide on how to decide whether to lease or buy assets.

How to avoid problems in your cashflow

No matter how effective your negotiations with customers and suppliers, poor business practices can put your cashflow at risk.

However, there are some practices you could introduce into your business to reduce the risk of cashflow problems. For example, you should think about:

  • Running credit checks on your customers to ensure they can pay you on time – see our guide on ensuring customers pay you on time.
  • Whether you can fulfil your order – if you don’t deliver on time, or to specification, you might not get paid. You should measure your production efficiency and the quantity and quality of the stock you hold and produce to ensure you can meet all your orders.
  • How effective your marketing strategy is, especially if your sales are stagnating or falling – see our guides on how to create your marketing strategy and how to reach your customers effectively.
  • How easy it is for your customers to do business with you. For example, if you could accept orders over the telephone, email or internet, customers may be able to pay quicker. You should also ensure catalogues and order forms are clear and easy to use to improve the sales and payment processes.
  • Keeping up-to-date accounting records to help warn you of any impending cashflow crises or prevent you from taking orders you can’t handle. See our guides on how to identify potential cashflow problems and how to avoid the problems of overtrading.
  • How you work with your suppliers – make sure they are not be overcharging or taking too long to deliver. See our guide on how to manage your suppliers.
  • Controlling your overheads – you could consider outsourcing non-core activities such as payroll services or review your utilities contracts to see whether it would be cheaper to switch tariff or supplier.

Sometimes after doing all you can, your cashflow forecast may still suggest potential cashflow problems. You should consider using temporary finance facilities such as an overdraft or credit card to see you through. Having a cashflow forecast to demonstrate the shortfall is temporary and will reassure finance providers.

Using your cashflow forecast to avoid overtrading

An adaptable cashflow forecast can be an invaluable business tool if it is used effectively.

It’s helpful to set up a regular review of the forecast, changing the figures in light of your sales, purchases and staff costs. Legislation, interest rates and tax changes will also impact on the forecast.

Having a regular review of your cashflow forecast will enable you to:

  • see when problems are likely to occur and sort them out in advance
  • identify any potential cash shortfalls and take appropriate action
  • ensure you have sufficient cashflow before you take on any major financial commitment

Having an accurate cashflow forecast will enable you to see when problems or cash shortfalls are likely to occur and work to avoid them. It will also enable you to prepare fully for growth by planning when and how much to invest.

Your cashflow forecast can also be vital in helping you to ensure you can achieve steady growth without overtrading. You will know when you have sufficient assets to take on additional business – and, just as importantly, when you need to consolidate. This will enable you to keep staff, customers and suppliers happy. See our guide on how to avoid the problems of overtrading.

You should incorporate warning signals into your cashflow forecast. For example, if predicted cash levels come close to your overdraft limits, you should have a contingency plan – eg by retaining some ‘back-up’ cash in another business bank account – to bring your cash balance back to an acceptable level. See our guide on how to identify potential cashflow problems.

Cash management in action

The following simple example shows how a small, profitable business can run into unforeseen cashflow problems when it takes on a new large order.

XYZ manufacturer is a small but profitable gift designer and supplier with three full-time staff (including the two owners). It outsources production, but supplies the raw materials itself to save on costs. It then finishes and packages the final product on site.

XYZ does not have any loans or overdrafts. It has a long-term customer base of small gift shops and visitor centres.

XYZ suddenly wins a large order to supply bespoke wall plaques for a chain of stores. The contract promises to double XYZ’s turnover.

The team takes on an additional employee and works flat out to meet the deadlines. It doesn’t notice an impending cashflow crisis resulting from a fall in repeat orders from existing customers, combined with a jump in raw material costs.

To make matters worse, the new client keeps changing its mind about designs. A misunderstanding means the first run of goods is rejected, causing a delay in payment and increased production costs. XYZ orders additional materials to make up the shortfall in the run.

By the time the order is complete, XYZ is running an expensive overdraft. Profit margins have been squeezed to the limit and it has lost several of its existing customers. A downturn in the fortunes of the retail chain means that it doesn’t place any further orders.

After a lot of hard work, XYZ finds itself back where it was five years earlier.

Tighter cashflow management would have highlighted the fall in repeat orders and rise in raw material costs. XYZ would also have benefited from a client contract that included:

  • milestone payments and penalty provisions for changes such as those to designs – eg increased fees
  • sharing the cost of additional materials with the new client or getting the client to pay for them

An illustration of the impact of the new order on XYZ’s cashflow.

CASE STUDY

Here’s how I manage my business finances

How you manage your finances can depend on the stage your business is at. In this video guide, two business owners share how they approached managing money in a growing business and a business in difficulty.

King of Shaves is a toiletries company started by entrepreneur Will King in 1993, which now has its products stocked in approximately 33,000 stores worldwide. Here, founder and CEO Will King talks about how he managed the business’ finances as King of Shaves grew.

Steve Wrieden, MD of the Hornbeam Group, realised the potential of an insolvent company he used to work for and took it out of administration. By evaluating the entire business, Steve was able to make confident strategic decisions to take the business forward. The Hornbeam Group now specialise in the building industry, offering loft conversions, home improvements and innovative subterranean structures.

Transcript

Will King

“Hi my name’s Will King and I’m the founder and CEO of King of Shaves. When we started up with our partners – so firstly with a big department store chain, second with a big multinational retailer – obviously it’s critical that you agree how you’re going to get paid, and they were very formal about that, so taking a big retail partner – they would send for a supplier pack, you had to complete that out, you’d then agree what the payment terms were – those were basically end of month following, so the payment terms would be between 30 and 60 days and then they would stick to that. We would never ship on what’s called consignment, which is where you sell a product and than you get paid when it sells because there’s no guarantee it’s going to sell, therefore no guarantee you’d get paid, so there would be a formal commitment there, but the retailers we deal with are very big, designed to deal with big trading partners who themselves require all the commitment. So I’ve always been very strict about what we do and how we do when it comes to shipping products and getting paid for it.

Early on the accounting I did myself and kept track of it all and all of the VAT and absolutely everything, and then over the last few years that’s now evolved into quite a sophisticated piece of accounting software, which doubles in with MRP – Manufacturing Resource Planning program, but early, the earliest was simply using spreadsheets and then printing out invoices and faxing them through and getting paid by cheque and then depositing the cheque. Now it’s all done by EDI – Electronic Data Interchange and sophisticated accounting packages.

Steve Wrieden

“My name is Steve Wrieden, I’m the managing director of the Hornbeam Group, which is a group of companies that we’ve developed over the last few years.

“Up to the time when I took the business over, being paid late by our clients was often a difficulty. We used to have, we have a contract with our clients for the value of the loft conversion and it’s broken down into stage payments so they can see the amount of work that we’re doing for the amount of money we’re asking for and they can go up – it’s like a milestone really. So you know that when the floor of the loft has gone down that there’s a payment due, when the dormer goes out there’s a payment due, when the stairs are fitted there’s a payment due. What we didn’t do is we never sent out any information saying we were at that stage.

“When we took the business over we took on new accountants, we saw it as a good time for a fresh start in a number of ways, and the accountant that we took on has much tighter control of our money and the income and expenditure. So we put in new systems and new processes in which we could monitor money more tightly. We can see when money’s coming in, we can forecast the next three or four weeks to know how much money is coming into the business and also how much money needs to be expended out. We have management accounts on the business. We just treated it with the respect it deserves and realised actually, we don’t just build loft conversions, we are a way of bringing money in and getting money out, so we do look after it from that point of view.

“We have much tighter control on cashflow now than we had before. Now we send out invoices to them with requests for payments, asking them to pay us as it falls due, letting them know that we’re at that stage and it’s time for you to organise your money now. If we are late in being paid then we send a polite letter to them, saying that they have seven days to pay us and if they don’t we’ll stop work and sometimes we’ve actually had to stop work. We’ve actually had to just say, look, unfortunately we can’t continue this contract until we get paid the stage payment that you owe us and it’s amazing how many times people say, oh the cheque was just lying on the kitchen table and it’s amazing how quickly you get paid when you need to, so we’re a lot tighter with our clients – we don’t have massive amounts of money that’s outstanding to us or even bad debt and I think it’s down to the fact that we are tighter – in a nice way – we’re tighter with our clients. We want to be good stewards, honourable with what we have, and so if we’ve made an agreement to pay someone for a week’s work, we expect to be paid by our clients so that we can pay them and if they’re not going to pay us then we can’t pay them, therefore we have to go somewhere else and find the money to pay our wages.”

CASE STUDY

Here’s how I manage my cashflow

When Peter Spivack and his three partners opened their restaurant, Rendezvous, in Wallasey Village, Merseyside in 2004, they knew sound cashflow management would be key to success during that crucial first year. As managing director, Peter assumed responsibility for cashflow management.

WHAT I DID

Set up systems

“I prepared my first year’s cashflow forecast as part of my business plan, which helped me secure a start-up loan. I decided early on that I would review the forecast monthly, although I update the figures on a weekly basis to keep on top of things.

“I started off using Excel spreadsheets, but now I also use Sage accounting software. The software incorporates a range of reporting tools that let me present the information in whatever format I need. For example, I can see average spend per head at the touch of a button. 

“I also had a marketing plan and budget from day one. That may not sound like managing cashflow, but it’s actually crucial for keeping the cash flowing in.”

Manage suppliers

“We arranged with key suppliers to be billed quarterly for the biggest costs. That makes budgeting and planning easier. We also negotiate 30-day accounts with suppliers wherever we can, which definitely helps cashflow. 

“We’re fortunate that our customers pay for goods and services at the time of purchase, but we still need to control outgoings. I’m always looking for ways to cut costs without affecting quality, such as switching suppliers if necessary and negotiating discounts on one-off purchases.”

Use the forecast to spot problems

“It’s no good having the figures if you don’t actively use them. For example, we used to open at lunchtime seven days a week, as well as evenings. As business picked up, I was considering employing another chef to help us cope.

“I analysed the figures to see how much extra cash we were likely to collect, compared to the increased staff expenditure. I concluded that we would actually be better off keeping staffing levels the same, but only opening Tuesday to Saturday evenings.

“The forecast has also enabled me to spot looming cash imbalances on three occasions. I didn’t panic because I could see the problem was only temporary. I used a pre-arranged overdraft facility to tide us over, confident that the money could be paid back the following month.”

What I’d do differently

Get accounting software sooner

“Incorporating all the financial information in one place with accounting software has been a great help in managing cashflow and I wish I’d had it right from the start. It also makes it easier to prepare our end-of-year accounts and means I have up-to-date figures whenever I need them.”

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One response to “Cashflow management: the basics”

  1. Measure performance and set targets – Kraken Business

    […] Cashflow – this is the balance of all of the money flowing in and out of your business. You should ensure that your forecast is regularly reviewed and updated. For more information, see our guide on cashflow management: the basics. […]