It’s often said that businesses don’t die of lack of profit, just lack of cash and this is as true today as it ever was.
Companies that can’t pay their bills when due will find that creditors patience tends to run out very quickly and debt collection action can be the result. Eventually, this could lead to a company insolvency situation.
There are things that you need to do to make sure you have the maximum working capital at any one time:
- Make sure you are adequately financed at the start. Money should go into your business long term and not short to finance your working capital so this means either investors buying shares or raising long term loans. That way you do not constantly have to rob Peter to pay Paul. One of the most common reasons that start-ups run out of money is over-optimism. Whilst you have to be an optimistic person to start up in business the fact is that you need to have a healthy dose of realism when producing your budgets and forecasts.
- Get yourself a decent overdraft. There will always be times when things are tight, getting an overdraft is the minimum you should do, but do it at a time when you don’t need it and not when you’re desperate. We often hear of businesses lamenting the fact that banks are only keen to lend money when things are going well so when things are looking rosy you should put in place a contingency for when that big customer is late paying their bills.
- Negotiate the longest credit terms you can with your suppliers. Use their bank balance instead of yours to finance your business. It’s like a free loan. This is what all of the biggest companies do. If you get it right then you can sell your goods before you even need to pay for them. This is exceptionally efficient for cash flow purposes.
- Don’t give people outrageous credit terms. Fair enough you need the sale but if you have to wait 3 months to get the money then it may cause issues. It’s the opposite of point 3 and you have to remember that if you give people long credit terms then you’re financing their business. It’s often very tempting to give large customers long credit terms to get the business but that can be even worse as you have to then find a way to finance your cost of sales whilst you wait for payment.
- Get the admin right. If your invoices are inaccurate then it gives the debtor time to argue the case but they won’t do this on day 1, they’ll do it on the day you ring up to ask why they haven’t paid. Disputing invoices is one of the oldest tricks in the book to get a bit more credit. Similarly make sure that you get Purchase Order (PO) numbers for orders (large companies often won’t pay unless you quote one), get delivery notes to show they have had the goods and get work signed off. This will stop firms finding ways not to pay promptly.
- Invoice quickly. I once worked for a company that only ever invoiced on the 30th of the month. This means that the work they did on the 1st took a month before it was invoiced and another month before it was paid. As soon as you have confirmed delivery or signed off work then get your invoice in as that’s when the payment clock starts ticking.
- Get a credit controller. Make sure people pay when the invoice is due otherwise you will find yourself financing their working capital instead of yours. A good credit controller is worth their weight in gold but if you can’t afford a full-time person then either look to appoint part-time or outsource to one of the excellent companies that do this professionally.
- Use leasing and HP to buy equipment. It can often be more tax-efficient but is always more cash efficient. You can then use your cash for working capital instead of tying it up in machinery. It’s important to match the financing type with the activity that you are looking at. So, for example, longer-term loans, equity or leasing for fixed assets and property.
- Don’t hold large stocks. Slow to move, expensive stock is just your money sitting on a shelf. Consider dropshipping to your customers or getting stock on sale or return. Remember also that having a large stock means a large warehouse so every item sitting on a shelf is costing money in the form of rent, rates, electricity and wages for every day that it sits in stock. Look to use Just in Time (JIT) techniques to reduce your inventory.
- Avoid prepaying wherever possible. Paying for things as you go along rather than giving suppliers your money to hold for a year unless of course there’s a compelling business case, (of course the opportunity here is to get your customers to prepay). Make sure you get reasonable credit terms as soon as you have built up a good business relationship with your supplier. If they refuse credit then look around for an alternative supplier and let your original guys know what you are doing and why.
- Do a cash flow forecast. Once you go through the discipline of actually writing things down then issues start to jump out. Keep it up to date and you’ll see problems appearing much earlier too. A good cash flow forecast will put everything in focus and give you advance warning of times that you are going to need to find extra cash.
- Don’t forget the profit. I know we said they are different things but an unprofitable company can only carry on as long as the cash holds out. Eventually, lack of profitability leads to lack of cash unless you have a very understanding bank manager.
It can’t be emphasised too much that cash is really important to companies. An unprofitable company can live indefinitely as long as they have cash enough to pay their creditors when due. A profitable company will die very quickly if they have no cash to use for working capital.
Using the tips above won’t guarantee your company will avoid insolvency but they will help to stop creditors taking action because you haven’t paid your bills.
If you would like to talk about how we can help you with your cash flow then why not get in tough now?