Businesses fail because they run out of cash. It’s the lifeblood of businesses great and small, new and well established. If your business runs out of cash, you won’t be able to pay your suppliers on demand, nor have enough working capital – the money you need to run your business day to day. Game over.
So what can you do?
Calculating how much working capital you have can help you to better understand how efficiently you’re running your business and how good its financial health is in the short term.
To calculate your working capital, you take away your current liabilities from your current assets.
|Current liabilities||Current assets|
|What your business owes to its suppliers and creditors.||Cash, any temporary investments, money you’re owed by your customers, stock, supplies – anything that could easily be sold for cash.|
One working capital ratio, the “current ratio”, can tell you whether your business has enough cash to cover money it owes. You can work out yours by dividing your current assets by your current liabilities. A ratio of between 1.2 and two is good.
Anything significantly above two could mean your business isn’t making full use of its assets to drive sales and growth. You shouldn’t get lured into a false sense of security, because liquidating cash tied up in stock or materials can take longer than you want. Bad debts or late payers can also mean your business’s financial health is not as rosy as its working capital ratio would suggest.
A ratio of one or less suggests that your business has "liquidity problems" (ie is less able to access the cash it needs to pay its debts). So, what can you do to make sure you have enough working capital?
It’s key to remaining lean and efficient. It can help to ensure that you have enough cash to stay afloat. The less you spend, the less working capital you’ll need. Eliminate waste in all areas of your business. Don’t buy anything unless there’s a valid business reason. Don’t tie up too much cash in stock or materials. Negotiate fairly but firmly with all your suppliers and ask for best-value deals or explore other options.
Are your prices high enough? You might be (unnecessarily) worried about putting them up, but even small price increases can make a big difference to your cash flow. Could you sell more to your existing customers? Have you explored all the ways to sell your products or services? What about new channels (eg selling online)? Which new customers could you target? What about customers overseas?
If you grant credit, any delay in sending out invoices will impact your cash flow. Include all essential details in your invoices and email them to the right person. Your customers should know your payment terms (30 days is standard). Be proactive when chasing customer invoices. Contact the customer shortly after sending the invoice to identify if there are any issues or disputes in advance of the due date that could prevent payment. Follow up prior to the due date with payment reminders. Be friendly and professional, but determined – it’s your money. By law, you can charge interest for late payment by other businesses.
17% of all payments to UK-based small to medium-sized businesses arrive after the due date.
Planning and forecasting can help you to identify times when your business risks running out of cash, so you can act before it’s too late. What are you regular costs and income streams? Are there times of the year when you expect a high volume of sales? Conversely, when do you normally see a slowdown in sales? Monitor your cash flow against the forecast and identify any causes for variance.
For starters, credit-check new customers before granting credit. Don’t approve any credit until the relationship is more established and even then – set credit limits. Carefully consider the cash flow implications of large projects before taking them on. Better still, ask for some cash upfront or agree staged payments. You could offer small discounts for early invoice payment (better still, money off future purchases).
Invoice finance is one way you to keep your cash flow healthy. Basically, for a fee, a finance provider advances sums on your unpaid invoices, while either you or they pursue payment. This can provide you with the cash to cover your costs and ease some of the strain caused by slow-paying invoices.
Maintaining healthy cash flow and ensuring that you have enough working capital should be key objectives for your small business. If not, one day you could seriously regret it. Cash is king and always will be.
Lloyds Bank supported 100,000 businesses last year to start up and helps businesses of all sizes, from small businesses to large corporates and financial institutions to fulfil their growth ambitions. For more information on improving your cash flow and working capital visit lloydsbank.com/workingcapital.
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