Cashflow management

With interest rates rising to their highest level for 14 years and the UK entering a recession that’s expected to continue through at least 2023, businesses of all sizes are having to tighten their belts. But while multinationals can sit on huge cash reserves to weather the storm, small and micro enterprises lack that safety net.

Maintaining a positive and steady cashflow is therefore more important than ever; but over half of UK small businesses have experienced problems with cashflow, which can have disastrous consequences when it comes to sustaining a business in a hostile economic environment.

For accountants working with SME and micro business clients – and accountants working in SMEs or micro businesses – the cashflow question is critically important. This makes cashflow a key area where accountants can add significant value to the businesses they work with.

Why is cashflow important?

Cashflow is simple to explain: it’s the flow of cash coming in and going out of a business. For most businesses, cashflow is different from financial reporting of profit and loss. This is because traditional accounting works on the accruals concept, where income and expenses are recognised in the accounts when the revenue is earned or the cost is incurred; not when the cash changes hands (the exception being cash basis accounting, which can be used by small self-employed businesses). If a business completes a job for a customer and invoices them in March, traditional accounting would recognise the revenue in March even if the invoice wasn’t settled until May.

If a business is selling goods or services with credit terms, and buying their raw materials on credit from their suppliers, it’s exceedingly difficult to understand that business’ cashflow by looking at their statement of profit and loss (SPL). When you add a business’ other spending into the mix (rent, utilities, salaries and wages, insurance, etc.) and consider how the cash impact of that spending differs from how it’s recognised in the accounts, the distinction between cashflow and SPL is clear.

So cashflow is distinct – but it’s no less important. Poor cashflow management can negatively impact a business in several ways:Additional costs (in the form of overdraft interest or late  charges)

• Inability to expand or make the most of new opportunities
• Damaged reputation with suppliers, limiting ability to negotiate better terms going forward
• Damaged reputation with lenders, limiting ability to take on long-term finance
• Decreased resiliency (to market disruption or economic downturn)

Some of these negative impacts can become self-reinforcing and lead to a business-endangering negative spiral.

How can accountants help?

The first step to positive change is understanding the problem. Accountants can help their clients, or the business they work in, by first helping them visualise and understand their cashflow. You can produce a simple cashflow forecast by identifying when, for each category of income and expenditure, cash comes into or goes out of the business’ bank account.

For some spending, this will be clear from contractual arrangements. For example, it should be transparent when rent, insurance and salaries are paid out. These can be plotted into the months when they will occur and reconciled with the master budget to ensure the totals match. Remember that the cash profile will probably look different from how the costs are reported in the SPL. For example, rent will usually be spread evenly over the year in the SPL; but if rent is paid to the landlord on a quarterly basis, it’s those quarterly payments that will be visible in the cashflow forecast.

Where credit terms are offered or taken, the cash impact of sales and cost of sales are harder to forecast. Here, you can calculate the average credit period taken by customers, and the average credit period taken by the business from its suppliers:

 Average credit period to customers =

(average receivables in period / total credit sales over period) * number of days in period

 Average credit period from suppliers =

(average payables in period / total credit purchases over period) * number of days in period

So, if a business had average receivables of £10,000 over the course of a financial year, during which said business made £100,000 total credit sales, their average credit period given to customers would be:

£10,000 / £100,000 * 365 days = 36.5 days

If the business’ average payables were £5,000 and they made £75,000 total credit purchases, their average credit period taken from suppliers would be:

£5,000 / £75,000 * 365 days = 24.3 days

In this case, giving customers a longer credit period than they’re taking from suppliers (36.5 days compared to 24.3 days) will exacerbate any cashflow problems and risks the business is facing.

Calculated average credit periods can be applied as an offset to budgeted sales and cost of sales figures and plotted into a cashflow forecast on this basis. With the cashflow forecast finalised and reconciled with the master budget you now have a visual tool to show month-on-month or week-on-week cash movement which you can use to identify risks and opportunities arising from projected periods of cash deficit or cash surplus.

 Advising on deficits and surpluses

If your cashflow forecast identifies potential deficits or surpluses you can advise on courses of action the business owner or management might consider. What advice you give will depend on whether the projected deficit or surplus is short or long term:

A receding and uncertain economic climate poses several risks to small and micro businesses, including the negative impact of poor cashflow. By guiding your business or clients towards a better understanding of their cashflow, and how to effectively manage it, you can help them survive and even thrive.

 The IFA is running a four-part webinar series on strategic planning and business partnering in the first half of 2023: the first two webinars, Budgeting and Costing and Forecasting and Planning, will include further information on cashflow forecasting and management.