Many business owners are watching their sales growing and winning new orders. But rather than celebrating a rising bank balance, they are struggling with less available cash.
It’s one of the strange realities of running a successful business. Growth can consume cash.
In fact, the faster some businesses grow, the greater the pressure on their cash flow becomes.
And that cash flow trap can catch perfectly profitable businesses – and it’s one that becomes particularly important to understand as your company gets bigger.
More sales don’t always mean more cash
Imagine you win a substantial new contract. You’re celebrating the good news. But before your customer pays you, you might need to:
- Recruit additional people
- Buy materials or stock
- Pay suppliers
- Invest in equipment
- Cover wages
- Increase your premises or operating costs
Your costs start now. Your customer’s payment might arrive in 30, 60 or even 90 days. That gap has to be funded from somewhere.
The ICAEW explains that growing businesses can experience cash-flow problems precisely because each additional sale needs working capital. Businesses may need to carry more stock and provide customers with credit before receiving payment.
So you can be selling more, making a profit and still find your bank account under increasing pressure.
The £1 million turnover problem
There isn’t anything magical about reaching £1 million turnover. It sounds great. But it often represents a point at which a business has become considerably more complicated than it used to be.
You might have more employees, more customers and an increasing number of suppliers. Add to that a larger monthly payroll and higher VAT bills as well as more cash tied up in stock or work in progress and you can start to see the issue.
There are usually significantly larger sums sitting in your debtor book waiting to be paid, too.
When you were turning over £300,000, one customer paying a week late might have been irritating. At £1 million or £2 million turnover, several substantial customers paying late can create a very different problem.
This is why growing businesses need to think about working capital, not simply profit.
The British Business Bank describes working capital as the money a business needs to maintain its day-to-day operations. It’s what enables you to pay employees and suppliers while continuing to operate and grow.
And growth can require a surprising amount of it.
The customer hasn’t paid. But everyone else needs paying.
This is where the cash-flow trap becomes particularly obvious. Your customer might have 30-day payment terms.
But then they pay 7 days late. Or 14, even worse 30!
Meanwhile, your employees expect to be paid on time. So do HMRC, your landlord, your finance providers and many of your suppliers.
You effectively end up financing the gap.And late payment remains a significant issue for UK businesses.
Research published by the Office of the Small Business Commissioner estimated that £26 billion is owed to UK businesses in late payments at any given time. More than 1.5 million businesses are affected each year, while businesses affected by late payment spend an average of 86 hours a year chasing money.
For an established business, good credit control therefore isn’t simply an admin function.
It’s an important part of managing growth.
Stock can swallow cash too
If you’re a product-based business, increasing sales can mean holding considerably more stock.
And stock sitting in your warehouse represents cash that isn’t sitting in your bank.
The same principle can apply to work in progress. You may have spent weeks – or months – paying people and suppliers to complete a project before you’re in a position to invoice the customer.
The business may be performing brilliantly. But the timing of when money comes in and when money goes out can create a substantial funding gap.
That’s why looking at your profit and loss account alone doesn’t tell you everything you need to know.
Then there’s tax
There is another common cash-flow mistake. Looking at the bank balance and assuming all of the money belongs to the business.
It doesn’t. Some may effectively be earmarked for VAT.
You may have PAYE and National Insurance liabilities approaching. And there could be a Corporation Tax bill on the horizon.
A healthy bank balance today can give a misleading picture of how much cash is genuinely available to spend.
This becomes increasingly important as the numbers get larger.
A business owner making a £5,000 investment decision and one making a £100,000 investment decision need very different levels of financial visibility.
The problem with managing cash through your bank balance
It’s tempting to log into online banking and use the number on the screen as a measure of how the business is performing.
But your bank balance tells you where you’ve been. It doesn’t necessarily tell you where you’re going.
Imagine you’ve got £150,000 in the bank. That sounds comfortable.
But over the next eight weeks you have:
- A VAT payment.
- Payroll
- Supplier bills.
- Corporation Tax.
- A new employee starting.
And then there’s the issue of £80,000 of customer invoices that may or may not arrive when expected.
Suddenly that £150,000 doesn’t look quite so reassuring.
That’s why a growing business needs a cash-flow forecast.
Look forwards, not just backwards
A useful cash-flow forecast should help you see what is likely to happen to your cash over the coming weeks and months.
It can show when the pressure points are likely to occur. And that gives you time to do something about them.
Perhaps you need to chase debtors sooner, renegotiate supplier terms, delay a capital purchase or arrange finance.
None of those decisions is particularly easy when you discover the problem three days before payroll.
They’re much easier when you’ve seen it coming three months in advance.
Can you afford that new contract?
This might sound like a strange question. Surely more business is always good? Not necessarily.
Before taking on a significant new customer or contract, it’s worth asking:
What will we have to spend before we get paid?
If winning a £300,000 contract requires £100,000 of additional working capital, you need to know where that £100,000 is coming from.
The contract might be profitable. But can the business finance it?
That’s a very different question.
And it’s one of the reasons financial planning becomes more important as businesses grow.
Growth needs to be funded
There’s a natural tendency to think that financial problems happen when businesses aren’t selling enough.
Sometimes the opposite is true. A successful company can grow itself into a cash-flow problem. More customers require more resources. More sales create more debtors. More employees increase payroll. And more stock absorbs cash.
And all of those things can happen before the additional income reaches your bank account.
The answer isn’t to stop growing.
It’s to make sure your finances are keeping pace with your ambitions.
Do you know what your cash position will be in 90 days?
That’s perhaps the most useful question to take away from this article.
If you can answer that confidently, you’re in a much stronger position to make decisions about recruitment, investment, new contracts and expansion.
If you can’t, it may be time to look more closely at your management information.
Get help identifying the cash flow trap
At Concept Accountancy, we believe your accounts should help you make decisions about what happens next – not simply record what happened last year.
For a growing business, understanding profit is important.
Understanding when that profit actually turns into cash can be even more important.
Because the biggest threat to a successful growing business isn’t always a lack of work.
Sometimes it’s having more work than your cash flow can comfortably support.
If that sounds interesting to you, then contact our team today for a chat about how we work.
