SMEs must keep a close eye on their cash flow and credit terms if they are to maintain good financial health. So what are the common causes of cash flow problems and what can you do about them…
Cash flow problems
‘Cash flow’ is the difference between the amount of money coming into a business from sales and investment, and the amount leaving from payment of bills, wages etc.
Unfortunately, these two aren’t always aligned – businesses are often unable to acquire sufficient funds in time to cover their outgoings. In the short term, businesses may be forced to take out a loan to cover the gap, absorbing the cost of the interest. In the long term, late payments can affect credit scores and damage relationships with suppliers and staff.
In its most basic form, poor cash flow can be caused by low profits. Simply without sufficient cash coming into a business, there won’t be enough to cover bills. Over time, this will eat into any savings and can lead to businesses running out of cash entirely.
Another cause is overtrading. If a business focuses too heavily on expansion and not enough on profitability – it can lead to significantly more cash leaving the business than coming in.
A third reason is demand fluctuation. If a business sells a product or service that is seasonally-dependent, it will have peaks and trough in demand. In this case, cash flow must be carefully forecasted to avoid being caught short.
Cash flow problems can be exacerbated by late payments from customers. Research by the Asset Based Finance Association (ABFA) found that British SMEs in 2015 were owed a total of £67.4bn in unpaid invoices – a figure that has grown by over a third since 2011. What’s more, SMEs are now waiting an average of 72 days to receive payment for their invoices.
Big companies are typically slower to settle outstanding invoices than smaller companies. Without a solid system in place, late payments can easily spiral out of control. And over time, unclaimed revenue can accumulate, putting you in a financially difficult position.
Credit control can help
One solution to late-paying customers is to offer a cash incentive to those who pay within the terms of the agreement. However, while this will certainly help to make sure you get paid promptly, it will eat into your profit margin.
A more effective solution is to implement proper credit control. This is a system that ensures you only extend credit to customers and clients who are able to pay on time – minimising the risk of being left high and dry by debt gone bad.
Two key elements of good credit control are identifying and assessing risk and setting terms and conditions to protect yourself before signing a contract.
The more you know about the company you’re doing business with, the more accurately you can appraise the risks involved in providing credit. Running a credit check is the quickest and simplest way of eliminating any uncertainty. There are many companies out there who can help you with this including CreditSafe UK and Experian.
When you’re satisfied by the other business’s credit rating and are happy that the risk is acceptable, it’s time to set the terms and conditions of the arrangement. Setting concrete rules prior to signing an agreement is an essential part of good credit control.
First, you must examine your own finances and ensure your business can survive financially in the time between delivering the service and receiving the payment. Once you’re happy, consider the following:
- Setting a maximum credit limit on the customer – this decision should be based on information from your credit check.
- Taking out credit insurance to protect against bad debt.
- Calculating exactly how much you can afford to lose – you should never risk more than you have.
Good credit control is largely a result of good planning. If you research diligently, check everything and plan for the worst, you’ll be in a strong position to reclaim your finances if things go bad.
If you would like to review your business’s cash flow and discuss how you can make improvements, call ESP on 01476 862 172 to arrange a meeting.