What is cash flow?
Cash flow is the movement of money into and out of your business over a period of time. Money coming into the business can include customer payments, while money going out can include supplier bills, wages, tax, rent and other business expenses.
Cash flow is different from profit. A business can be profitable on paper but still experience a cash-flow problem if customers have not paid invoices yet or significant bills are due before expected income arrives.
Understanding when money is expected to arrive and when it needs to be paid out can therefore be just as important as understanding your overall profit.
Create a simple cash flow forecast
A cash flow forecast estimates the money you expect to receive and pay over a future period. It can help you identify potential shortfalls before they become a problem.
Start with your current bank balance and list expected cash coming in, such as customer payments and other business income. Then list expected payments, including suppliers, wages, rent, software, finance, VAT, PAYE and other tax liabilities where relevant.
A forecast does not need to be complicated. The important thing is to update it regularly and use realistic assumptions about when customers are likely to pay and when bills will actually need to be settled.
Invoice customers promptly
The sooner you issue an accurate invoice, the sooner your customer can normally process and pay it. Delayed invoicing can create unnecessary gaps between completing work and receiving the money.
Make sure invoices contain the information your customers need, including the correct customer details, invoice date, payment terms, amount due and payment instructions.
If you provide services on an ongoing basis, consider establishing a consistent invoicing routine rather than waiting until you have spare time to raise invoices.
Set clear payment terms
Clear payment terms help customers understand when payment is expected. Make your agreed payment terms clear in your contracts and invoices.
Keep track of outstanding invoices and follow up promptly when payments become overdue. A polite reminder can resolve many late-payment issues without damaging the customer relationship.
For larger pieces of work, you may also consider whether staged payments or deposits are appropriate for your business and the type of work you provide.
Monitor outstanding invoices
Knowing how much customers owe you is an important part of managing cash flow. Your accounting software should make it possible to review unpaid invoices and identify overdue amounts.
Do not assume that money shown as sales or income in your accounts is immediately available to spend. If the customer has not paid, the cash has not yet arrived in your bank account.
Regularly reviewing your debtor position can help you identify customers who consistently pay late and decide whether your credit terms or payment process need to change.
Plan for tax and other large payments
Tax bills can create significant cash-flow pressure if they are not planned for in advance. Depending on your business structure, this could include Income Tax, Corporation Tax, VAT, PAYE and National Insurance.
Keep an up-to-date estimate of your likely tax liabilities and consider setting money aside for upcoming payments rather than treating all money in the business bank account as available to spend.
The timing of tax payments varies depending on the tax involved and your circumstances, so check the relevant HMRC deadlines and build them into your cash-flow forecast.
Control regular business expenses
Review your regular business expenses periodically and make sure you understand what each recurring payment is providing.
Software subscriptions, insurance, professional services, premises costs, finance payments and other regular commitments can add up over time. Reviewing them does not necessarily mean cutting costs, but it can help you identify unnecessary or duplicated spending.
Before taking on a new regular commitment, consider its effect on your future monthly cash position as well as whether the expense is affordable today.
Separate business and personal money
Keeping business and personal finances separate can make it much easier to understand the true cash position of a business.
Using a dedicated business bank account can help you identify business income and expenditure, simplify bookkeeping and make it easier to reconcile transactions.
If you operate through a limited company, remember that company money belongs to the company. Personal withdrawals should be recorded and treated correctly rather than simply being taken from the business account without explanation.
Keep your bookkeeping up to date
Up-to-date bookkeeping gives you a clearer picture of what your business is owed, what it owes and how much cash is available.
Leaving bookkeeping until the end of the month, quarter or year can make it harder to spot problems early. Regularly recording transactions and reconciling your bank account can provide much better visibility.
Cloud accounting software can make this process easier by bringing transactions, invoices and other financial information together, particularly where bank feeds and automated tools are available.
Do not confuse profit with cash
Profit and cash flow are related but they are not the same thing. A sale may be included in your accounts before the customer has paid, while a business may make a large cash payment for equipment or other costs that does not immediately appear as an equivalent expense in the profit calculation.
This is why reviewing both your profit and your cash position is important when making business decisions.
If your business is growing quickly, cash-flow management can become particularly important because you may need to pay suppliers, staff and other costs before receiving payment from customers.
Build a cash buffer where possible
Having some cash available for unexpected costs can give a business more flexibility when income is lower than expected or an unexpected bill arises.
The appropriate level of cash reserves will depend on the type, size and circumstances of the business. A seasonal business may need a different approach from a business with predictable monthly income.
Rather than relying on a fixed percentage, consider your regular commitments, payment patterns, tax liabilities and the potential for unexpected costs when deciding how much cash your business should retain.
Use your forecast to make decisions
A cash-flow forecast is most useful when it influences decisions rather than simply being prepared and forgotten.
Before making a large purchase, taking on additional staff or committing to a new monthly expense, consider how the decision could affect your expected cash position over the coming months.
If the forecast shows a potential shortfall, you have more opportunity to investigate the cause and consider your options before the problem becomes urgent.
When should you get professional help?
If you regularly struggle to predict your cash position, have significant overdue invoices or are unsure how much money is available to spend, professional support may be useful.
An accountant can help you understand your management information, prepare or review cash-flow forecasts and identify areas where your bookkeeping or financial processes could be improved.
The earlier you understand a potential cash-flow problem, the more options you may have to deal with it. Regular financial reviews can therefore be useful even when the business appears to be performing well.
A simple cash-flow checklist
Review your bank balance regularly, update your cash-flow forecast and keep your bookkeeping up to date.
Raise invoices promptly, monitor overdue amounts, plan ahead for tax and other major payments and review recurring expenses.
Finally, distinguish between money that is genuinely available to spend and money that needs to be reserved for upcoming liabilities. A clear view of your cash position can help you make better-informed business decisions.
These guides provide general information. If you need accountancy or tax support based on your circumstances, contact Digital Tax.