The order book looks healthy and the accounts say you made a profit. Yet every month payroll, VAT and rent land at once and the bank balance barely covers them. The causes are usually findable and fixable.
Learning how to improve cash flow in a small business starts with a simple truth: cash is king. Whatever is going wrong, it eventually shows up in the bank account. The ten areas below cover Balance Sheet issues and profitability issues.
1. Check whether your business is under capitalised
An under capitalised business simply does not have enough capital to fund its day-to-day running. The symptoms are frequent cash squeezes and no spare money to invest in growth.
It is common in young companies that underestimated start-up costs, and in established firms growing faster than their cash. Research by the German credit rating agency Creditreform found that almost a third of UK companies had an equity ratio below 10% in the 2009 financial year, and it linked weak capitalisation directly to a higher risk of insolvency.
Tighter control of stock, debtors and creditors may buy you time, but the real answer is usually more capital, not more short-term debt. That might come from your own resources, family and friends, a Business Angel or, for high-growth firms, venture capital. Work out exactly how much you need before you ask.
2. Keep your drawings in line with profit
It is often said that around 70% of new small businesses fail within three years, and excessive drawings are one reason. Owners keep taking a set amount in drawings or dividends regardless of performance. Often only the year-end accounts reveal they took out more than the business earned in net profit.
If this is happening, you have three options: cut your drawings, improve profitability or go bust. And get cash out of the Balance Sheet: profit tied up in stock, work in progress, debtors or unused fixed assets cannot pay you.
3. Tighten your debtor control
Debtors are the customers who owe you money for goods or services supplied on credit. They are the asset closest to cash, so they are the first place to look. Customers paying outside your terms are using you as a bank.
To find your debtor days, divide your debtors by annual turnover and multiply by 365. With debtors of £50,000 and turnover of £250,000, that is 73 days. On 30-day terms, that means nearly £30,000 sitting in your customers' accounts instead of yours. A disciplined system makes the difference:
- Make one person responsible for collecting debts.
- Set clear terms of trade, such as strictly net 30 days from date of invoice.
- Invoice as soon as possible after the sale.
- Send statements on day 31 or 61, then chase by phone, then a solicitor's final demand letter.
- Run regular credit checks, set credit limits and stick to them.
- Treat every customer the same, with no special cases, and watch the local and trade press for warning signs.
4. Bring stock levels under control
Most businesses have far too much cash tied up in stock and work in progress. Buying in bulk for a supplier discount may help profit, but it can be disastrous for cash. The "just in time" approach keeps stock at a skeleton level, provided you have a supply chain that delivers the right product at the right time, every time.
Monitor your stock turn, which shows how many times stock turns over in a year, and know what good looks like for your sector. A fast-food outlet turns its stock over several times a week; a distributor of combine harvesters far less often. If just in time does not suit you, sell off slow-moving or obsolete lines, rationalise your product range, or negotiate sale or return terms so you only pay when a customer buys.
5. Take full advantage of creditor terms
Many owners pay suppliers too soon. Do not stretch beyond agreed terms, but use the full credit period. Divide trade creditors by turnover and multiply by 365: with creditors of £15,000 on turnover of £250,000, you are paying in about 22 days. On 30-day terms, that early payment has absorbed around £5,500 of cash. Moving to 35 days would give a one-off boost of nearly £9,000.
Before you delay anything, rank your creditors. Your financial backers, your landlord and suppliers with no alternative must be paid on time. Utilities can cut you off, HMRC can surcharge automatically and asset finance companies can repossess equipment. Then ask trade suppliers for better terms; most businesses never renegotiate the terms given when they had no track record. The worst they can do is say no.
6. Sweat your assets
Sweating your assets means making sure your people, machinery and premises are working hard enough. If any are under-used, find more work or cut capacity. Bankers were once trained to be wary of a flag pole, new cars in the car park or a large fish tank in reception: image over substance. Ask yourself:
- Is there equipment you rarely use that could be sold, freeing both cash and space?
- Are you using far more office or workshop space than you need? Could you move, or partition and sublet?
- Are redundant vehicles kept "just in case"? Sell them, consider flexible rental, and look at a cash alternative to staff cars.
7. Use a cash flow forecast to secure the right working capital
A growing business needs more working capital, and banks can bridge the gap with an overdraft, factoring or Confidential Invoice Discounting. To ask for the right facility, you need a cash flow forecast.
Cover a year or 13 weeks, by month or week (daily if things are very tight). List receipts due, payments to be made, the excess of receipts over payments, and the opening and closing bank balance. Be realistic: on 30-day terms, do not expect the money on day 31. Without one, you cannot sensibly plan anything else.
8. Know your breakeven point and margin of safety
If the bank cannot help, look at profitability. Your breakeven point is overheads divided by gross margin percentage. Overheads of £50,000 and a 50% gross margin means breakeven sales of £100,000.
Use gross margin, not mark-up. A 100% mark-up on the same figures wrongly suggests breakeven at £50,000; plan around that and you would lose £25,000 in the year. Once you have the right figure, work out your margin of safety. Forecast sales of £120,000 against breakeven of £100,000 gives 20%. The smaller it is, the higher the risk.
9. Have the confidence to increase your prices
If you cannot easily sell more, raising prices is the main way to increase profit. The real question is how many customers you could afford to lose.
If you believe that you only have price to compete on you may as well give up as you will always be on the back foot.
Nigel Moore
Take a widget bought at £2.75 and sold at £5.00, with 15,000 sold a year: a gross profit of £33,750 and a 45% margin. Raise the price by 10% to £5.50 and the margin becomes 50%. You would now need to sell only 12,273 units to make the same gross profit, a fall in volume of just over 18%. If you honestly believe you would lose fewer customers than that, act quickly, and sell on what makes you remarkable, often your knowledge and service, not price.
10. Control your overheads
Challenge yourself to find ways to cut your total overheads by 10%. Set an annual budget for every line, from rent and rates to stationery, and monitor it monthly.
Wages are usually the biggest overhead. If labour costs run above 40% of sales, your workforce may not be efficient. Premises and rates often come next, so move or sublet unused space. Because most overheads are paid monthly, every saving shows up in your cash flow almost immediately.
Where to start: how to improve cash flow in a small business this week
Pull last year's accounts and calculate two numbers: your debtor days and your creditor days. Compare both with your terms of trade.
Then pick the bigger gap and act on it. That might mean making one person responsible for chasing debts every week, or paying suppliers on the due date rather than the day the invoice arrives.