Every business needs cash to survive. You can survive without sales or profits for a time – but you cannot survive without cash. Businesses need cash to pay suppliers and employees – and they receive that cash from customers. The need for cash increases as the business grows. It is vital to be able to monitor the flow of cash from your customers to you, and from you to your suppliers and employees. 

Business plans must take account of the flow of cash so that the maximum amount of cash can be generated – or that arrangements can be made with finance lenders to enable the business to achieve its aims. Acting on up-to-date information is the key to running a successful business.

This guide identifies the key elements of what to monitor and provides an insight into maximising cash flow.

The customary way of assessing the trading performance of a business is to prepare a trading or profit and loss account. This can, however, fail to highlight the movement in the key performance element in any business – cash!

Key elements of the profit & loss account

The profit and loss account is the formal report that sets out how the business is doing. It records sales and the cost of those sales, together with overheads and other expenses, and shows whether a profit or a loss has been made.

The rules for preparing a profit and loss account ensure that a clear picture emerges of profitability. These are the main elements:

• Sales. The summary of sales that have been invoiced, together with an estimate of work in progress. It takes no account of which invoices have been paid and which are outstanding.
• Cost of sales. The summary of purchases which have been made (invoices received from suppliers), together with an estimate of the cost of items used but not yet paid for (accruals). This again takes no account of which invoices have been paid and which are outstanding.
• Other expenditure and overheads. These items include the cost of invoiced items but also include accruals for expenditure not yet invoiced. Overheads tend to be spread over the accounting periods to which they relate. Rates, for example, could be paid once per year, but the cost could be spread in the profit and loss account over a complete year. 
• Depreciation. This represents the cost to the business of using fixed assets during the trading period. The cash used to buy the fixed assets is often spent as the asset is bought, but the cost of using the asset in the business may be spread over several years.
• Profit. The resulting profit, shown in the profit and loss account, represents profit generated rather than cash generated. This is because it includes items not yet paid for, cash not yet received, and items not involving a cash movement – depreciation.

Key cashflow elements

The cashflow within a business is the summary of cash flowing into and out of a business. It takes account of:

• Trading items
• Capital or non-trading items

Trading cashflow

Sales cash

• The main flow of cash into a business is from the sales activity. Depending on the type of business, there can be a delay between making the sale and receiving the cash.
• Retailers tend to get paid for their sales immediately, either in cash or by credit card – unless they are selling goods on credit.
• Other businesses set down the trading terms they want their customers to adhere to. These can vary greatly depending on the business – payment in seven days, 14 days, 30 days or perhaps longer.
• Long-term contracts tend to contain provisions for staged payments as the contract goes on. This helps the cashflow of both supplier and customer.
• It is important that you persuade customers to abide by your trading terms, as you will be using these assumptions in preparing your cashflow forecasts. 
• The addition of VAT to a sales invoice (assuming you make standard rated sales) provides a complication for the cashflow forecast. VAT is collected by you with your sales cash, but paid over with your VAT return – probably quarterly.

Purchases/overhead payments

• Cash flows out of the business as you pay for purchases or overhead items.
• The timing of these payments will depend upon the trading terms of the businesses you are doing business with.
• These can vary depending on the type of purchase you are making and whether you have established a formal relationship with them.
• If you open an account with your suppliers, they will be more willing to let you have goods or services on credit. Using credit terms allows you to safeguard the cash within your business.
• Several organisations allow customers to spread the payments they need to make over several months – for example, rates can usually be spread over an instalment plan.
• Many businesses use purchasing or charge cards for making smaller value purchases. This gives an advantage in the timing of payments by buying the goods or services immediately while paying for them with a monthly charge.
• Payroll payments to employees tend to be made on a monthly basis – this reduces the number of payrolls you need to run.
• Payroll deductions are paid over at a different time to the net pay. The deductions and net pay need to be summarised to reconcile to total payroll cost.

Non-trading or capital items

• Capital, or non-trading, items can become cash flowing into or out of a business, for example the sale of a director’s car, or the cash purchase of a new machine.
• Capital expenditure will include payments for fixed assets or other investments. As these tend to be large transactions, there is often a chance to negotiate special payment terms. So staged payments for large capital investments can be common.

It is also possible to introduce other forms of financing to delay cash outflows, such as:

• Bank loans 
• Hire purchase 
• Leasing

The flow of capital items into the business can include:

• In the case of companies, investments from shareholders – share capital.
• Long-term loans – these can be structured to meet the needs of the business bearing in mind the cashflow forecast prepared for the business.

Forecasting cash flows

The cashflow forecast summarises month by month the cash flowing into and out of the business. The format can differ but seeks to show:

• Sales cash flowing into the business
• Cost of sales and overheads flowing out of the business
• Payroll costs
• Capital cash flows
• Loans etc. going into the business
• Capital repayments out of the business
• VAT and other taxes
• Total cashflow

Having started with the cash at the beginning of the period, it can quickly be seen how the available cash balance moves as a result of the items detailed above.

Effective forecasting

• Forecasting the flow of funds takes account of future activity – sales cash, purchase payments, capital items – but you can also draw a lot of information from previous activity. For example, is there a seasonal aspect to your business, and if so, how does this affect your cashflow?
• Sales cash received as per trading terms. Will your sales cash be received in accordance with your established trading terms? Or will you have some customers who can’t, or will not, pay?
• Account needs to be taken of the real trend in cash collection. If your business offers trading terms of 30 days, it could take an average of 50 days to collect your money.
• This collection profile is important and should be used in the forecast. It can be a useful way of measuring the effectiveness of the cash collection routine.
• Remember the 80:20 rule. Perhaps 20% of your customers will represent 80% of your sales, so keeping the top 20% within payment terms can have a dramatic impact on cashflow.

Long-term contract sales, staged payments, deferred terms

• Just as your business will be keen to take advantage of deferred payment terms, so your customers may expect the same.
• This particularly applies to long-term contracts allowing both parties to spread the cashflow from the transaction.
• Large transactions often require negotiated terms and these need to be borne in mind when planning cashflow forecasts.

Planned expenditure for purchases, overheads, capital

• The benefit of planning for cash flowing out of the business is that you are fully aware of when that expenditure is to happen.
• You can take account of the cash flowing into your business so that you have sufficient cash to continue to trade normally.
• You will have ordered the goods or services and will be aware of the trading terms of the people you are doing business with.
• The cash outflows can be seen as being more certain – and you are certainly more able to influence them.
• A review of past cashflows can also help when looking to the future.

Costs can be incurred but the cash flow is different!

• Costs can be incurred now which will apply to the business for a full year in advance, for example, rates, or, for a full trading period, payroll costs.
• The phasing of payments and how they differ to conventional accounting rules is one of the quirks of the cashflow forecast.
• Reviewing previous cash flows can give a clear insight into these sorts of transactions which will need review.

Detailing when VAT becomes due

• VAT is charged on most transactions for businesses registered for VAT and VAT that is added to your sales needs to be paid over to Customs & Excise. 
• VAT incurred on purchases can be offset against this payment –allowing you to reclaim any VAT paid.
• The standard way of paying or reclaiming VAT is quarterly, but there are exceptions – for example, if you regularly reclaim VAT you may be able to do this monthly and so help your cashflow.
• The fact that part of the sales cash received must eventually be paid over to Customs must be borne in mind as cashflows are forecast.
• Similarly, part of the cost of purchases (the VAT) may be deducted from the sales or output tax.

Detailing when PAYE/NI and other taxes are due

• The cost of employing staff includes not only the gross pay, but also the cost of employer’s National Insurance contributions.
• You need to account for how the cashflow differs from the recording of costs in the business.
• The immediate cost to the business is gross pay plus National Insurance. The cashflow will differ in that net pay (gross pay less deductions) is payable to employees – normally at the end of the month.
• Deductions made during the month (which actually ends on the 5th of the following month) will be due to be paid over by the 19th of that month. This complication will need to be taken into account in the cashflow forecast.

Measuring against forecast

Having prepared a cashflow forecast, we need to monitor how the business performs against it in reality.

This provides details not only of how the cash is moving into and out of the business, but also shows how accurate our assumptions are.

If customers are paying your invoices more slowly, you need to build that change into the next forecast – or get your customers to abide by your trading terms.

• The monitoring against the cashflow forecast can take place over different timescales, depending upon:
  • The nature of the business. 
  • The scale of the cash flowing into and out of the business.
  • Whether forecast assumptions require additional funding.

Just as cashflows can highlight shortfalls in funding within a business, so too can they highlight whether surplus funds are being generated. This would allow the business to invest those surplus funds to its benefit.

The benefit from preparing timely cashflow forecasts is that you have early indications of both good and not so good events. This allows you to take early action to avoid possible problems and to maximise returns on cash generated within the business.

Maximising cash flow

All businesses must seek to maximise cashflow – to generate the maximum amount of cash in the shortest possible time.

Set out below are some pointers to maximising cashflow.

Sales cash

Trading terms

• Set your trading terms to collect your cash as soon as possible. Quick payment helps you.
• The generally accepted rule of 30 days to pay does not apply to all businesses and can be a matter of negotiation.
  • Retailers are paid for their goods before they leave the shop.
  • Garages ask for payment before handing over a new vehicle.
  • Mobile phone companies insist on payment by direct debit – they decide when they will collect the remittance!

Credit control

• Decide to concentrate the sales effort on the best customers and best prospects.
• Carry out credit checks before the sales effort starts. 
• Open credit accounts only when you are sure that the customer is a good risk – either from references taken up or from their trading record with you.
• Establish sensible credit limits – to ensure that you do not have too much exposure to any one customer.
• Make sure that customers and staff understand the policy and how it works in practice.
• Make sure that your sales and delivery note documentation is clear to avoid queries.
• Insist, where appropriate, on official customer orders.

Debt collection

• Be firm when discussing late payment with customers.
• Schedule a telephone call to your bigger customers before the due date to ensure that your payment is given priority.
• Have a short chasing routine with few written reminders. The telephone call remains the most effective way of collecting debts.
• Set targets for collection by your debt collection team.
• Make it easy for customers to pay – many businesses are now using purchasing cards and electronic payment methods.
• Consider using Direct Debit as a means of collecting your cash. This is efficient and controlled by you.

Purchases/overheads

Trading terms

• Try to agree extended payment terms wherever possible.
• Operate a monthly payment routine.
• Pay suppliers electronically by BACS if possible.

Credit accounts

• Credit is normally only extended to customers with accounts.
• Open credit accounts with your main suppliers.
• Concentrate your purchasing power with a few suppliers to enable you to negotiate better trading terms. Shop around regularly, though.

Purchasing cards

Reduce the number of small accounts demanding attention by using corporate procurement/ purchasing cards. These allow small purchases to be made efficiently and provide you with a period of credit. Small-value purchases will then be paid for within a monthly timescale.

Capital items

• These tend to be large transactions, which give the opportunity of looking for efficient ways of paying for the investment.
• The investment is likely to generate a positive cashflow, which can be managed by spreading the cost of the purchase.
• Loans. Armed with cashflow forecasts and an appraisal of the proposed investment, consider applying for a business loan. This can spread the cost over an extended period.
• HP, leasing. Alternative forms of spreading the cost can be considered.

Managing the balance sheet

• In addition to trading and capital items, a business needs to manage other areas of the business.

VAT

• Consideration should be given to the way you account for VAT – an election can be made for monthly returns when refunds are normally due.
• Collection and payment of VAT on your transactions is done monthly (along with your transactions), but it is paid over quarterly.

PAYE/NI

• Deductions from the payroll for pay as you earn (tax) and National Insurance contributions are due for payment by the 19th of the month following payment of the payroll.

Hire purchase and other loans

• The cost to the business of using HP or loans is an interest cost. There will also be an element of capital repayment.
• The timing difference of using this form of payment must be borne in mind in the cashflow calculations.