It's important to remember that whilst both are important measures to business owners, investors and trading partners alike, cash and profitability are not the same thing.

The differences between cash and profit

  • Profit is usually seen as an accounting measure, highlighted in the accounts as a snapshot at the end of some period of time, to show the health of the business, and hopefully, to show a better result when compared year on year.
  • Profit however does not show when the revenue from the sales you have made will be realised, when the money actually gets into your hands and whether that will be before or after you have to pay for the new delivery van or this week's direct debits.
  • Cash is much more immediate and cashflow forecasting and working capital management help ensure that there are enough funds to meet obligations today, to pay wages and suppliers and continue trading.
  • Shortfalls in cash available to small businesses often lead to the failure of those enterprises, even where the underlying profitability is sound.

Planning for the future

Planning the management of cash is not a trivial exercise and should be viewed as a key management activity for small businesses. As a planning tool, you should expect to be questioned on anticipated cashflows whenever you go for a bank loan. Particularly in these times where credit is restricted, banks will only lend when they can see that there is a history that the business is in control of both its short and long term financial health.

Suppliers too may be more wary than in the good times of lending to someone who may fail owing them money or supplies they can't recover. You might find that payment terms, credit limits and even whether they are prepared to do business with you will all be favourably influenced by evidence that you understand how your business operations are funded.

Cashflow forecasts and working capital management

There are a number of measures you can take to actively manage your cash position and the mix of working capital:-

Cash inflows

  • Credit check potential customers to make sure they are likely to be in a position to pay you, if they will be significant customers for you, ask to see their cash flow forecasts.
  • Also look to set payment terms you are comfortable with, given your knowledge of your industry, the customer, and the value of their business to you.
  • Once you have set payment terms, implement them and chase debts. If the customer has signed up to terms of 30 days, remind them that its day 28 now and confirm that you will feature in their next payment run. If you do this regularly they will view this as business as usual, rather than a sign of desperation.
  • If that fails to have an impact on receiving payments promptly, consider debt factoring services. For a percentage outlay, you can receive the remaining balance of the amounts outstanding. Debt factoring also has the advantage that you are not the one on the phone arguing for payment, so if the business relationship with the customer can continue, it can do so in an un-soured atmosphere.
  • Finally you can look to review customer risk constantly. Just because a business has been able to pay in the past doesn't mean they will continue to be able to pay going forward.

Making Payments

  • If a supplier offers 30 days payment terms, use the days. Don't feel you have to pay everything the day the invoice comes in but do make sure your planning supports that you will be able to pay and avoid souring the relationship or incurring extra costs.
  • Build relationships with suppliers and call them to extend your credit terms. Chances are that once they have done business with you for a while they will be able to re-assess your credit history and may offer better terms themselves anyway, but what's the harm in asking?
  • Some payments may be immovable though and every effort should be made to ensure these are met. Missing paying HMRC can lead to automatic interest and/or penalties, whilst missing finance lease payments could jeopardise the infrastructure of your business.

Stock Control

  • You can also consider more actively managing your stock levels. Buying less but more often could mean that you are able to more closely match purchases with sales in at least some areas of your business.
  • Whilst a "just in time" approach may in some instances lead to unacceptable stock shortages or additional purchase or delivery costs, it may be worth considering.

In short paying close attention to the detail of everyday business should put you in a better place to steer day to day operations successfully.

Plan to succeed

Save a bit of love for your accountant too. As an independent source of advice, they can be invaluable in helping build cash flow models to best practice and in instilling rigour in helping you establish your working capital management metrics.

However you choose to do it, you ignore cash management at your peril. To succeed, be robust and process driven, seek help where you can get it, tell everyone how your interaction with them helps what you are doing  and ensure that you control your cash and that it doesn't control you.

How to manage Cashflow easily

As an accountant I have recommended Sage One to clients who own small businesses and need a simple solution to manage cash coming into the business and cash going out of the business. Sage One is an online solution, so it's easy to use for businesses who want to do their accounts on the move.

 About the author - Paul Donno is the founger of Paul Donno & Co Ltd, a firm of accountants and business advisors based in Suffolk. Paul has worked closely with Sage since his practise was established in 1993 and is one of many leading accountants championing Sage One in the UK.