Why and how to manage cash flow

Cash flow is the movement of cash into and out of a business or ‘receipts’ and ‘payments’...

Receipts include; cash from sales of goods or services, bank loans, cash introduced from private sources (e.g. savings), sale of fixed assets (eg. company van), and cash invested to purchase company shares.

Payments include; cash to suppliers for stock and expenses, bank loan repayments, purchase of assets (e.g. computer equipment), plus VAT, PAYE, NI and wages.

In the longer term, any business which uses more cash than it receives will run out of cash resources and may be forced to close down. In the short term, having insufficient cash resources is usually more of a problem than being unprofitable, as a shortage of cash means that bills cannot be paid. It is the demand for repayment from creditors, or the refusal of suppliers to continue to offer credit which are major causes of business failure.

What is the difference between profit and cash flow?

It is important to understand that profit is not the same as cash – even when a business makes a profit this will not necessarily generate cash in the short term.

Many businesses will offer credit to customers in order to win sales and, to some extent this may be balanced by credit obtained from suppliers. Many businesses will have to buy stock from suppliers before they receive cash from selling the product or service to customers. Even when a customer buys the product or service, if you’re extending credit then it will be some time before the cash flows back into your business.

While a business may be profitable because a customer has bought your product for an amount more than the cost of providing it, your business will still have seen a cash outflow until final repayment is received.

Looking at the profit of a business on its own can therefore give an incomplete picture of how the business is performing – even a profitable business can get into difficulties if it runs out of cash. In fact, rapid growth by profitable businesses may well lead to shortages of cash, because extra money is needed to finance expansion (for example to buy extra stock or purchase fixed assets).

How do you manage cash flow?

Your cash flow needs constant monitoring and planning to make sure you always have enough ready cash to meet your costs on time. Unless your cash flow is managed effectively and any shortfalls anticipated in advance, even profitable businesses can find themselves in serious financial difficulties.

Knowing you’ll have enough cash to pay a bill next month isn’t enough if the creditor is pushing for payment today. Good financial organisation and having a strategy to manage cash flow will reduce the likelihood of disruption to cash flow. A good cash flow management strategy includes the following five key elements.

1. Manage the credit you give

Making sure that your customers pay you on time is critical to effective cash flow management. It will be difficult to predict whether you’ll have enough money in the bank to pay your bills in one month’s time, if you don’t know when your customers are likely to pay you. For this reason, you should always contact customers whose accounts are outstanding and make sure that they pay immediately.

You have a right to charge interest on late payments and might need to consider legal action in more serious cases.

You might want to consider encouraging your business customers to pay you by card. More and more UK businesses are adopting commercial cards as a preferred payment method because of the cost savings they offer. Suppliers enjoy improved cash flow as they are paid by the bank within three or four days of the transaction taking place, whilst there is no need to chase outstanding, unpaid invoices.

2. Keep your books up to date

If your books are not kept up to date and accurate, your cash flow forecast and other reports will not be accurate. To manage your cash flow confidently and effectively, your records must be full and complete. Whether you have manual or computerised books, you should regularly set aside time to add in details of all income and expenditure and, crucially, invoices issued and bills received with their due dates. Bookkeeping software is the least time consuming way to manage your books and is widely available. If you would like to find out more about the types of bookkeeping products we have availalbe please visit our product and service pages.

3. Put contingency plans in place

Speak to your bank, or other lenders, to make sure that you will be able to borrow money at short notice. The amount should be enough to cover you in case of a customer failing to pay you on time. Don’t just assume you can extend your overdraft without prior warning. Your bank will usually be more favourable if you can give advance notice of any such activity.

4. Manage your bills

Make sure that you pay your own bills on time. In the event of a cash flow shortfall, your suppliers will be much more likely to extend you credit if you’ve built up a reputation for reliability.

5. Fund your business properly

It is important to ensure that all the money needed for the day-to-day running of your business isn’t tied up funding long-term commitments.

As a rule, if you need to borrow money for your business, long-term borrowing (such as loans) should be taken out to cover fixed assets (such as premises or equipment).

This means that you’ll be able to spread repayments over the longer term without causing disruption to the day-to-day finances. Additionally, you’ll be able to use extra income generated from the asset you’ve purchased to help make repayments to the loan.

Working capital finance (such as an overdraft) should be used to manage timing differences as your business may need to make payments to suppliers while you are awaiting the receipt of payment from customers.

Having the right solutions in place can help you manage your cash flow effectively, your bank can also help, so it's worth making an appointment to see your personal advisor. For information on how Barclays can help your business, visit the Barclays business banking website.