Many small business owners will know that cash is key to a business’ survival. On the surface, it’s enough to know that as long as your income exceeds your outgoings, the business will be ok. But what are some of the common cash flow mistakes that small business owners make? I’ve rounded up my Top 10 here, and finish off with a few top tips on how to avoid them.
1. Cash does not equal profit
Top of the list is assuming that cash equals profit (or vice versa!) This is one of the most common mistakes I come across as a small business accountant. Businesses who think that because they have money in the bank, they’ve made a profit, or that the cash in their bank IS their profit. If you business has made a profit, this profit is then used to cover tax liabilities, loan repayments, credit card repayments, asset purchases (such as a laptop, machinery or a vehicle). It may also pay for dividends to the shareholders in a limited company.
2. Overestimating future sales volumes
For a cash flow forecast for your own purposes, you should always err on the side of caution. Be realistic with your sales projections and if, after a couple of months, you realise you were way off target – revisit your targets and adjust them.
3. Low profit margins
This is especially true in product businesses but also applies to service businesses. The expenses that directly relate to your sales need to be factored into your pricing strategy. In a product business this could be:
- the costs of materials
- merchant fees and so on.
In a service business, it could be some software that is purchased specifically to carry out your service, any subcontractors or staff that assist you in the delivery of your service. If your Gross Profit % is not at the right level, you won’t have enough to cover the overheads in the business, or cover your drawings as a business owner.
4. Poor stock management
This is aimed at product-led businesses. If you don’t look after your stock, you will end up with wastage or money tied up in products gathering dust on a shelf. There are a few ways to improve stock control that I will cover at the end of this article.
5. Not having a budget
Your budget doesn’t have to be a rigid or restrictive budget – think of it more as a ‘spending plan’. If you overspend in one category – what category can you take the money from that month to cover the shortfall? You can obtain basic budget templates online where you can set a target, and review it with the actuals each month. This can prevent impulse spending.
6. Not having a cash flow forecast
It has recently become apparent that whilst a lot of business owners know that cash is important, that many do not see the importance of a cash flow forecast. Being able to anticipate cash flow dips can work wonders – both mentally and financially. Suddenly discovering you don’t have enough money to fund your VAT bill is not something you want to have to deal with (potentially every three months!).
7. Not having a buffer fund
In personal finances, many individuals would create an emergency fund. Small businesses are just the same. What will you do if your laptop suddenly blows up? Or you have to fix your website? Do you have the funds to cover it? You’ll often have to rely on expensive credit in order to fund these if you don’t have a buffer fund in place.
8. Poor credit control
Unpaid invoices are one of the key causes of poor cash flow. Money sitting in your customers’ bank accounts instead of yours is not going to cover your tax bill, pay your staff, or help you grow your business. Prevention is better than the cure, so make sure you have robust processes in place to ensure customers understand your payment terms and pay you on time.
9. Growing too quickly
This can seem an odd one on the surface, but it is one of the big causes of cash flow issues. How will you cover the staff costs if you receive a large project to deliver? How will you cover the stock or materials purchase for a huge wholesale order? Before you take on a new client or project, you need to factor in if you’re in a financial position to deliver the work and, if not, your cash flow position might be better served by saying “no”.
10. Poor internal controls
And to finish off, I’m picking a broad one – poor internal controls. This does in fact incorporate some of the above points, but if you don’t have good organisation, you will struggle with cash flow. Not having up-to-date or accurate financial information will cause significant problems, especially as you grow. If you take out a loan to fund a cash flow gap, but you don’t have the relevant information to know how it’s going to be spent, you’ll find it has quickly disappeared and you have nothing to show for it.