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Cash flow – why cash is king for small business
It’s a cliche but cashflow is king in business – especially for small businesses. Another old business saying is that ‘happiness is a positive cash flow’. Cash flow is crucial to business survival, and needs to be managed, as this article will cover.
What is cash flow?
Cash flow is, most basically, the amount of money entering and leaving a business. Cash comes in, cash goes out. Income comes from clients, finance, investments, or interest on savings. Money goes out on operating expenses, for example, stock, materials, rent. As a business, you are aiming for a positive cash flow (known as net operating cash flow), that is, that you have more coming in than going out.
Why is it important?
Without incoming cash flow, your business won’t survive. It’s that simple. It might last a few months or, if you’re rich enough and can subsidise the business, even a few years but, ultimately, the money will run out. Surveys show that up to 60% of failed businesses cite cash flow as the reason they failed.
Managing incoming cash flow
Businesses need to ensure that they remain vigilant about their cashflow. If you’re in a business that requires payment at the time that the product or service is supplied, then this is relatively easy. If you’re a business that invoices after the event, it can be trickier.
As an example, I personally knew a longstanding and otherwise successful business that allowed its biggest client to rack up a massive debt. That client had always been a good customer before, so they weren’t particularly concerned when they didn’t pay their bills immediately. They continued doing work for them as the bill mounted up. It was only once the debt was over £100,000 that they started to ask questions, and found out that the client’s business was about to go into receivership. They learned a harsh lesson, and were lucky that their business survived.
No one wants to find themselves in that situation. If you are offering credit to clients, how can you manage your incoming cash flow to ensure it doesn’t happen to you?
Stay on top of your invoicing
Make sure you know what invoices are due, and when. Send your bills on regular basis, plus reminders as necessary. Chase up by phone or email if payment isn’t received when it should be. If this is something you’re uncomfortable doing, ask a friend or family member if they would do it on your behalf.
Offer card payment facilities
When someone tries to pay by card, you know immediately if the client has adequate funds to pay. If the transaction is approved, your payment is guaranteed. Accept cheques with caution, even business cheques. They can bounce, but you won’t know until you receive notification from their bank.
Offer a discount for prompt payment
Many companies offer thirty day credit terms. You could offer a small discount if, for example, they pay within two weeks.
This is where a business ‘sells’ its invoices to a third party, the factor. The factor pays the business’ invoices within an agreed timeframe, minus a percentage (usually 10-30%). The factor then waits for the money from the client. When the client pays, the factor pays the remainder of the invoice to the business, less a handling fee. If the client does not pay, it is up to the factor to pursue it.
The advantage for the business is that it is guaranteed to receive a large proportion of its invoices in a timely manner, regardless of when the client pays. A downside is that it can be rather expensive, and it can be difficult to understand what charges are applied, and how.
Stop credit lines
If someone hasn’t paid within a reasonable timeframe, don’t be afraid to refuse further service until you receive payment. If this is a regular occurrence with a client, start asking for payment upfront. While you may be worried about losing their business, it’s worth remembering that some clients cost more than they are worth to you. Poor payers fall into this category.
If, after an extended period of time, payment is not forthcoming, consider the small claims court (officially known as a county court in the UK). It’s inexpensive, and simple to do and, in the event of a successful claim, the other party is liable for your costs. For the UK, the guidelines can be found on the HMRC website here. The information for the United States, and state limits are listed here.
While pursuing legal action may seem scary, it’s worth bearing in mind that many people prefer to settle out of court. The threat can often be enough to jolt them into paying, plus having a County Court Judgement against them affects their credit rating, and so ability to obtain finance.
Successful businesses keep a close eye on their cash flow. This is especially important for small businesses who are don’t have the cash reserves to support losses for sustained periods of time. Keeping on top of your billing, chasing up late payments, and taking appropriate action when invoices remain unpaid will all ensure you stay in business.