A Business That Runs Out Of Cash Resources Is Dead In The Water

Category: Finance, Financial Planning.

Sales turnover and net profits may follow a rollercoaster pattern familiar to most business but when the cash flow dries up the game is over. Accounting software can offer many solutions but there is no substitute for astute management to boost cash flow and reduce liquidity risks.

Cash flow management is critical not just to business performance but to business survival in the days and months of a credit crunch. Most businesses will experience periods of lower sales and times when losses may be incurred as expenses exceed sales income. A business that runs out of cash resources is dead in the water. With a sound business the position is recoverable by gaining extra sales growth or reducing expenditure. Debtors and sales income management. Payment terms offered to customers should be clearly stated and fixed as standard accounting figures according to the amount of funding the business is prepared to offer its clients.

The objective is to obtain payment from customers as fast as possible improving cash flow and minimising the risk of bad debts and not being paid at all. Because that is exactly what credit terms to customers is, free cash funding in exchange for eventual sales income. In some businesses it would be appropriate to obtain up front deposits and scheduled payments. Consideration should be given to using a cash discount system to encourage sales invoices to be paid faster. Review this practise to obtain a greater proportion of payments faster to improve liquidity. All new customers where credit check details are not available should be invoiced by the accounting function on a pro forma basis. New customers should be subjected to a strict credit check.

Any businesses who fail to meet the highest credit score required should remain on a pro forma invoice basis. An essential process in the credit control procedure would be to ensure the accountant or bookkeeper always issues sales invoices and customer statements promptly. Each business should determine a set of credit control procedures including issuing sales invoices, producing customer statements of outstanding balances and a standard set of credit control letters that actually get the cash in. Incorporate into the terms of trade a set of rules to invoke interest payments for late payment and late payment debt recovery costs. Consider the possibility of factoring sales invoices due from debtors either by selling the sales invoices to a third party or raising cash on the value of those invoices pending payment. In the UK the Late Payment of Commercial Debts( Interest) Act 1998 sets out the statutory rights of business to claim interest and costs.

Factoring has the disadvantage of often not being cheap but does have the advantage of generating a regular stream of cash. A bad debt not only uses valuable resources in chasing the debt with the negative impact on cash flow and liquidity but also is a straight loss to the net profit and a strong indicator that the accounting function is failing the business. Bad debts have a double impact on any business and all possible steps should be taken to reduce the risk. Creditors and expenditure management. Consider the frequency of all payments made to suppliers. The objective is to extend the time allowed for payment of expenses the business incurs.

Small business often has alternative payment terms available for the payment of taxes. Consider the frequency which wages and salaries are paid. In the UK value added tax can be paid quarterly or monthly, vat cash accounting can ease the tax liability due in critical periods and paye payments can be paid quarterly rather than monthly for smaller businesses. A sensitive area since it involves the most important people to the business success but adopting a payment period to coincide with the receipt of cash from customers may in some circumstances balance liquidity. Larger orders on extended payments terms creates a risk area should the goods not be used but can greatly assist cash flow as the business is effectively borrowing free cash from its suppliers. General creditors are a major area to be addressed in terms of both the amount of credit received from suppliers and the time required to pay those creditor accounts.

Stock levels are crucial to financial management of the creditor total. Higher levels of stock financed by free credit from creditors lowers the cash flow requirements on the other parts of the business. High stock levels use valuable working capital which is offset in part by the level of creditors.

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