However, if you are aware of what may lie ahead, you can anticipate and avoid problems.
Every business has different challenges, but there are a number of familiar scenarios. These include:
- Initial underfunding - this is a common problem often due to underestimating the cash required.
- Insufficient sales and/or inadequate profit margins - essentially, if you can’t sell enough products with the right profit margin, it won’t be able to pay its way.
- Rapid but poorly planned growth - sudden expansion can require investment long before the associated revenues come in.
- Too much money tied up - cash invested in non-liquid assets, such as stock or machinery, may leave you short of cash.
- Late payment - poor invoicing and debt-chasing processes can be really costly.
The common factor in all of the above is a shortage of available cash. These cash flow problems can even afflict businesses that are doing well by other measures such as sales and margins – lack of cash flow is the number one business killer.
In order to survive, the money coming into a business every month, plus any reserves and loan facilities must at least match your outgoings.
So make forecasts for the months ahead, and look at sales and expected cash flow. If they begin to fall below forecasts, you should take immediate action. Regularly ask yourself the following questions:
- Are sales falling?
- Are you losing market share?
- Is your reputation suffering when compared to your competitors?
- Are you being forced to borrow more in order to cover operational costs (rather than investment)?
Is it becoming increasingly difficult to pay creditors?
If the warning signs are there, act quickly. Initially, problems may not seem that serious. Sales may be slightly down or the cash coming into the business may not quite meet the outgoings.
The business carries on as normal in the hope that next month’s cash flow and sales figures will improve. However, if figures don’t improve, the business could find itself inundated with demands from suppliers and it may be difficult to pay staff.
If the problems aren’t resolved then the result can be insolvency. The key is to be pro-active with measures that will put your business back on an even keel.
What should I do
By spotting the early warning signs, you will be in a much stronger position to put things right.
For instance, if your cash flow difficulties are related to sales figures, then a first step is to trade your way out of the problem. If the resources are available, step up your sales and marketing. Sell more to existing customers and tap into new markets.
If the time-delay between the raising of an invoice and the customer paying is causing cashflow problems, there are a number of possible solutions. These include:
- Focus on winning business that will generate cash quickly.
- Tighten credit control. Make sure invoices are sent out on time. Chase payment when it becomes due.
- Consider factoring or invoice discounting arrangements, where cash is lent to you by the bank as soon as an invoice is raised.
Keep track of the financial health of your customers and suppliers.
- Change payment periods.
- If there is no real chance of sales improving, then you should consider other measures such as selling assets, cutting staff and reducing costs and/or inventory in order to free up cash.
Talking to your bank and investors
Make the time to regularly talk to your bank. For instance, if your problems are caused by a lack of available finance due to overly rapid growth, a bank is more likely to provide the funds if the problem is identified early and brought to its attention.
Similarly, the bank will be more willing to provide solutions such as invoice discounting if it’s clear that management has been quick to address a problem.
If your financial situation threatens your ability to meet existing repayment obligations, banks are more likely to be sympathetic if you talk to them early and present a credible business plan. Investors (if you have them) should also be kept aware of the situation.
The one thing you should never do is trade while insolvent. If the company runs out of cash, then it is illegal to take orders from customers or take goods on credit from suppliers. There are serious penalties for breaking this rule.
However, the definition of insolvency is complex and it’s not always easy to know when you’ve crossed the line. If in doubt, seek advice from your lawyer or accountant. If you are insolvent, the next step may be administration.
Administration and involuntary arrangements
Administration occurs when a company’s financial difficulties prompt creditors, stakeholders, or sometimes the directors themselves, to apply for a court order to begin the process.
While it sounds drastic, administration needn’t be the end of the road. Under the recently enacted Enterprise Act, the accountants who take over the running of a company in administration have a duty to do all they can to return the business to operational health.
A variation on the theme is administrative receivership. This occurs when a creditor or lender has a claim on the company’s assets to cover non-payment. In these cases the role of the receiver is to recover assets for that particular creditor.
One useful means of getting through a period of crisis is to reach a formal agreement with creditors under a Company Voluntary Arrangement (CVA). Under these agreements, creditors and the company agree a legally enforceable recovery plan. Once a CVA is in place, creditors can’t sue for repayment for an agreed period of time and the company has time to recover.
Similarly, sole traders with debts of less than £5000 can apply for an administration order, which will allow them to pay the courts an agreed monthly sum that will be divided among creditors.
- Get help and guidance about your bank problems - winding up, bankruptcy, receivership and administration.
- Limited liability partnership administration guidance
- Read about administration charge requirements
- Read about how to avoid insolvency
- Find a chartered accountant in the UK
- Prepare sales and cash flow forecasts and act if performance falls short.
- Look out for warning signs – rising debts, inability to pay bills.
- Identify the problem and take appropriate action.
- Keep banks and other stakeholders informed of any problems.
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