Why Cashflow Is the Number One Thing Small UK Businesses Get Wrong — And How to Fix It

And here is an interesting fact about some businesses that may surprise new business owners: a firm can be profitable according to accounting statements and nevertheless lack cash.

It occurs quite frequently. A freelance consultant gets paid £8,000 worth of services in November but gets paid only in January; meanwhile, a tax bill comes at the end of December. A manufacturing business had the best month of all in October, but used up all its cash flow in September purchasing inventory. A growing services firm wins its largest client deal to date, but it will take ninety days for the client to make any payments, and the bills for salaries come monthly.

There is a difference between profit and cash flow, and understanding that difference is one of the most useful business management skills a person can gain with Anova. Here is your crash course in the basics, presented in clear language with no technicalities. 

What Cashflow Actually Means — And Why It Matters

Cashflow is just the flow of money into and out of your business. Money coming into your business customers paying their bills, credit cards, advanced payments, etc. is your inflow. Money leaving your business payroll, supplier payments, rent, HMRC, software costs, and more is your outflow.

When your inflows are greater than your outflows, you have positive cashflow. If your outflows are higher than your inflows, for any period of time, you have cashflow problems irrespective of the amount of money still owed to you by customers or how profitable your business appears on paper.

Here the word "temporarily" carries heavy connotations. Cashflow problems in most cases do not imply a permanent problem but simply the difference in timing. You have money coming in, it is just not here yet, and the task at hand is surviving until it arrives.

For small businesses, sole traders, and startups who cannot afford any cash reserves, the task can sometimes prove lethal. Understanding the areas where cashflow problems happen in your particular business should be your starting point.

The Most Common Cashflow Gaps And Where They Hide

Late-Paying Customers

This is the most prevalent reason why cashflow issues arise in services-based businesses. You have performed the service, raised an invoice, and now you wait. The norm in the UK is for payments to be made within thirty days, but many businesses – especially large ones – will make their payments within sixty or ninety days regardless of your invoice's stipulations.

The effect this will have on you is that you end up financing your customer's cash flow with your own. You provided the service, paid for its provision, and now you wait for several months while your bills keep coming in.

There are simple steps such as shortening payment terms, requesting deposit payments, and dealing with late invoices quickly. These steps do not involve aggression; rather, they simply involve professionalism in communications.

Seasonal Demand

Firms that go through seasonal highs, such as retailers at Christmas time, holiday resorts during summer or accounting firms due to January's self-assessment deadline, encounter a certain cash flow problem. Money comes in sporadically, but expenses are fairly stable throughout the year.

The way to deal with this problem is forward planning instead of crisis management. If you understand that January is going to be slow while December is going to be fast, you need to use your profit from December wisely instead of spending it straight away. It may seem obvious to create financial reserves during high periods to cover low periods, but it is easier said than done.

Rapid Growth

Certainly, growth itself is good. However, growth that occurs too quickly without proper cash flow planning could be dangerous for the company. The acquisition of new clients leads to extra expenses – more employees, more tools, more materials – but no income, because income comes later.

Overtrading is the term used when companies experience the kind of growth described above: their growth exceeds their cash flow capacity. Overtrading is one of the reasons small companies go bankrupt even though they are highly successful.

HMRC Payment Dates

There is no convenient monthly installment of tax to come into play. The dates at which the corporation tax, VAT repayments, PAYE and other self-assessment tax will come due are set out very clearly, and those businesses who do not plan ahead for their arrival may well face some major problems.

The HMRC is not like other suppliers and will stick to the timetable they follow, making tax bills one area where failure to plan ahead can have serious consequences.

Practical Ways to Improve Your Cashflow Position

Know Your Numbers Before You Need Them

A cash flow forecast, on the other hand, is nothing but an estimate of the inflow and outflow of cash in the future period – usually between three and twelve months. There is no need to make it complicated. A simple spreadsheet, which shows the anticipated income and expenditure, would give an idea of any future gaps. 

The benefit of forecasting is not because it will prove correct. On the contrary, it almost never does. Its real advantage lies in its ability to look into the future. You get three months in advance to make some plans and adjustments when you anticipate cash flow gaps three months down the line. You have few choices left when it comes as a sudden surprise.

Invoice Promptly and Follow Up Consistently

A cash flow forecast is simply an estimate of the amount of cash flow you anticipate receiving and disbursing in the future – generally, in the next three to twelve months. There is no need for this process to be difficult. A simple Excel spread sheet estimating your projected cash flows and expenses is all that is necessary to give you a heads-up on the areas where a shortfall is probable.

There is nothing magical about making forecasts since they are never totally accurate. But this does not mean that they are of no use whatsoever. The importance of forecasting lies in the fact that it makes you plan ahead. By giving you a heads-up about an estimated cash flow deficit in three months from now, you have three months' time to remedy the situation.

Build a Cash Reserve Wherever Possible

The cash reserve, which is funds saved solely with the purpose of meeting any cash flow problems and not dedicated to any other objective, represents the most direct safeguard against these problems. The amount that should be kept in a reserve depends greatly on the nature of the business, as well as its invoices and income predictability.

A cash reserve takes time to develop, especially at the beginning of a company’s operations, when the cash position is weak. However, a relatively small cash reserve is immensely important in case of unanticipated expenses or delayed payment from an important customer.

Understand Your Payment Terms on Both Sides

Your agreement on payment terms with your clients and the payment terms offered to you by your suppliers are two key factors that play an important role in shaping your cash flow position. The point is that if you are paying suppliers within thirty days, yet your clients take sixty days to pay you, then you are essentially financing their payments for thirty days out of your cash reserves.

If you are able to negotiate extended supplier payment terms, or obtain discounts from suppliers by paying early, this could help improve your cash flow situation considerably.

When to Get Professional Help With Cashflow

Cashflow management is something most business owners can develop a reasonable handle on themselves with time and attention. But there are situations where professional input genuinely earns its cost many times over.

If your cashflow problems are recurring as opposed to being sporadic, you may wish to take a closer look at the fundamental workings of your business model, including its pricing structures, payment terms and costs, by discussing this with an expert on business accounting. Furthermore, if you are about to embark on a period of growth, acquisition, restructuring, etc., having insight into what will happen with regards to cashflow prior to embarking on these ventures is beneficial. If your dealings with HMRC payments seem like an ongoing mystery to you, getting your tax affairs assessed by experts may help immensely.

Getting accountancy services from a firm that has expertise in small businesses and SMEs, as opposed to those that cater exclusively to large corporate clients, will ensure that the advice provided to you will actually address your needs. Anova is an accountancy firm located in the UK that provides their services specifically to small businesses, startups and growing SMEs.

The art of managing cashflow is one thing that the vast majority of business people will develop a reasonable knowledge of over time. There are, however, occasions when it really does pay off to take some professional help.

If your problems with cashflow appear to happen repeatedly rather than being a once-off thing, there may well be a fundamental flaw in your business model – whether that is in the way you price, make payments or manage your costs. If you are approaching a period of growth or change within your business then having some idea about the impact upon your cashflow beforehand is very helpful. And if dealing with HMRC feels a bit like an adventure and a series of shocks, then having a professional look at how you manage your tax obligations can make all the difference.

Using an accountancy firm with a real knowledge of the particular needs of small businesses and SMEs, rather than one geared towards larger corporations, is key to getting sensible advice. Anova Accountants work only with small businesses in the UK.

A Few Things Worth Knowing About Making Tax Digital

MTD stands for Making Tax Digital and it is the HMRC scheme for shifting record-keeping and submission to the digital format. MTD for VAT has existed for some years now whereas MTD for Income Tax Self-Assessment will soon be introduced for sole proprietors and landlords whose income is above some threshold amount.

The effect on small businesses is both of these types. On the one hand, record keeping must now be done in HMRC-compliant digital format instead of traditional paper methods. The second implication is that reporting to HMRC occurs more often through MTD for Income Tax, hence, record keeping is not something to be done just once a year but requires consistency.

MTD can be regarded as a hindrance or a challenge depending on the way the business handles the situation. Businesses with organized records that are updated constantly are going to have it easy while businesses that used to pull out their records annually will have a harder time.

Wrapping Up

Cash flow is certainly not the sexiest aspect of being an entrepreneur. Nobody jumps for joy about managing their cashflow the way they do over signing up a new client or rolling out a new product. Cashflow, however, is what turns all those fun ideas into reality.

Being familiar with the fundamentals such as the differences between profit and cash, the problems usually present in cashflow, forecasting and protecting yourself against cashflow issues leaves you in a much better position than the vast majority of small business owners, who tend to react to cashflow problems as they arise.

When things get particularly complex or when decisions need to be made that will have an impact on your bottom line, then it is exactly this time that you can reap real benefits from working with an accountant. Not just at the end of the year, but all year through, as a sounding board who knows his numbers and your business.

Frequently Asked Questions

What is the difference between profit and cashflow?

In this case, profit is referred to as the excess resulting when costs are deducted from income within a specified period of time. Cash flow, on the other hand, denotes the actual movement of money into or out of a business transaction. Sometimes there occur situations when a firm may be profitable but has problems in terms of cash flow since the clients pay at their convenience.

How far ahead should I be forecasting my cashflow?

It is wise for any small business to forecast at least three months ahead. Twelve months' worth of information will give you some insight into seasonal cycles and expenses that lie ahead. Remember that the purpose of forecasting is to plan ahead rather than make precise predictions.

What should I do if I think I am going to miss a tax payment to HMRC? 

It is recommended that you contact HMRC prior to the payment deadline instead of after you have missed it. This is because HMRC offers time-to-pay services that can help you stretch your payments should you be experiencing financial problems. The earlier you make this request, the better. An experienced accountant can help you do this.

Does Making Tax Digital affect all small businesses? 

The Making Tax Digital for VAT is already implemented for all VAT registered companies. For self-employed individuals and landlords who earn above certain income levels, the Making Tax Digital for Income Tax Self-Assessment will be rolled out in phases. The requirements that apply specifically depend on your business type and your income threshold – get in touch with an accountant to find out more.

When does a small business genuinely need an accountant rather than managing finances independently? 

Even small firms would greatly benefit from having a professional accountant involved from the very start at least for annual accounting and tax filing purposes. With a growing business and staff, as well as registration for VAT or other complicated financial decisions to make, having a professional by one’s side will be highly beneficial. A professionally skilled accountant can actually serve as an advisor to one’s business too, as opposed to merely being an accountancy specialist.

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