Essay on options open to a small business facing a cash flow crisis
Many small businesses will face cash flow problems throughout their entire lifecycle but almost certainly within the first 2 years of trading. These cash flow problems can be attributed to many different causes some examples are a decline in trade, non or late payment of invoices, unexpected one-off charges for repairs and renewals, an increase in price of raw materials, increase in competition etc.
Whilst the original business plan may have forecasted and accounted for some difficulties, the prediction of the future is not an exact science. What can cause cash flow problems and what measures can be taken to ease the cash flow crisis on these occasions?
Non or late payment of invoices Creditors should be sent a regular statement showing the money owed. This should be done on a monthly basis or more frequently dependant on your trading terms i.e. payment due 28 days from invoice date. If an invoice has gone past its due date a letter should be sent immediately, this should be followed by a phone call(s). If the debt still has not been repaid a personal visit often works.If these methods are not successful there are legal channels that can be used. You can instruct a solicitor to draft you an official letter or instruct a debt collection agency to collect the debt on your behalf. Charges will be made for these services, a solicitor will charge a flat fee for the letter, and a debt collection agency will charge you a percentage of the debt.
If bad debtors are a continual problem factoring services can be used. This is where a company buys your debt (often for a high percentage upfront) the remainder of the debt (minus the finance houses fee) is then paid once they have collected the debt from the customer. Care should be taken when allowing your customers credit. It is always worth remembering that the majority of suppliers to new small businesses will demand cash-on-delivery until you have established a successful working relationship. It is always worth the extra cost of sending for a companies credit file that wish to trade with you. A simpler system, which is free of charge, is to ask the company who wish to have credit to obtain references from other suppliers to them and also a banks reference. If the company have nothing to hide this is a very simple and swift procedure.
Extend your credit facilities overdraft, mortgage, or loan. Can you re-negotiate the terms of borrowing? Be this a longer repayment stage (say 7 years instead of 5) does your loan have a provision to take a repayment holiday? Have you accounts elsewhere if so can you switch lenders? It helps when you see your bank manager to have the exact reasons why your initial business plan is struggling and how you plan to repay the additional borrowing.
Vigorously target new contracts, get a written confirmation of the contract you have agreed and use this information to persuade the bank manager to increase your existing credit facilities. Banks and other financial lenders seek to reduce perceived risk on money lent. If you can show them agreed contracts for future work this massively reduces the risk of the money they are lending to you.
Share release Could you sell a stake in the business. Options here could be a family member, friend, competitor or supplier. If your business has been successful and the cash flow problem is only temporary, many people will be willing to invest. The advantage here is that the money does not need to be repaid. The negative is you have taken onboard another partner, silent or otherwise, and they are now involved in any future profit share and the future shape of the business.
Examine your fixed costs If you lease the building do you need all the space you have leased. Does your contract permit you to sub-let? Sale of capital equipment plant, computers, vehicles. If you own them it is possible to sell them immediately releasing valuable cash. If any of the items were essential to business then in the short term you can take the equipment back on a lease basis, this would release valuable cash.
Examine staff costs If you are a sole trader or partnership examine your own drawings first. Do you or your partners need to take this much monthly/weekly? Who are your other staff do you need them all? Could you reduce the hours they work? When reducing staff it is important to remember to keep them informed of the decision making process. If this cash flow crisis is a short-term problem they may be willing to accept a reduction in wages or hours to help you through. Your staff may take a long-term view and consider that having to take a pay cut or reduction in hours in the short-term is better than losing the job completely.
Injection of personal finances - Re-examine your original business plan, what has changed? If the business still has potential it is worth investing the savings you have. If you can only see limited potential then the best course of action may be to scale down or close the business. If the cash flow crisis is pointing to a much bigger problem then it is advisable to examine all alternatives, this also includes closure of the business. The harsh reality is that the vast majority of small businesses fail within 3 years. The most common reason that a business fails is poor cash flow management rather than poor profitability.
What is absolutely essential is to focus in on the causal factors of the cash flow problem. Can they be resolved? Is this just a temporary blip? This is a very demanding task, especially to a sole-trader or small partnership, as this is not just a job but also a way of life they have opted for. They will be tempted to look for failures within themselves (which could be a factor) but the simple truth is that their business must bear scrutiny and if close examination shows little room for improvement then the decision should be made to cease trading. If the causal factors are known and can be resolved then the cash flow problem can be used to benefit the future health and trading of the company.
Periodically it is wise to return to the original business plan and examine where you are currently with where you expected to be when you commenced the venture. Have you strayed away from your core product/service, is your turnover more or less than predicted, have you expanded more quickly than predicted? Answering these questions really helps to focus back in on what was important at the very beginning. When you have examined your business and realised the cash flow problem will not be permanent and the venture is viable then I would recommend the following steps.
Firstly approach the bank manager, clearly explain the situation you are in, what you have done to alleviate the problem, any future confirmed business you have and ask that they review the business credit limits with respect to your current borrowing limits. If the business also has a loan with the bank discuss a repayment break or a repayment restructuring. Always be mindful of the fact that when the business is trading well again you can re-visit the bank manager to repay the loan sooner. If you are frank, open and honest with the bank manager it is possible to build a close working relationship something that benefits both parties.
Secondly, vigorously pursue any bad debt, make the telephone call, pay the personal visit, this should be a polite meeting and should only happen once. If these methods do not work then involve a debt collection agency. Often if the debt has become this old it is worth using an agency as they have the time and resources available to chase the debt. It is often worth paying the fees to the agency and saving you valuable time. Your time can then be used looking for future work rather than trying to collect from work already completed.
Thirdly, if the business has capital assets that are non-essential dispose of them and re-invest the cash directly into the business. Many businesses will have a surprising amount of unused or redundant assets, these are often worth more than you think. Furthermore, evaluate all your other business assets that are owned outright i.e. vehicles, premises. Is it necessary to own them or would a lease agreement free up valuable cash? High profile examples of this type of sale and leaseback are premiership football clubs.
These three steps should alleviate the crisis in the cash flow problem and allow the business to trade normally again. The exercise of re-examining the key business aims stated on the original business plan should help with shaping the future of the business ultimately re-focussing efforts on what your company has a competitive advantage in.
Tags: business plan, cash flow problems, finance houses, small business, solicitor
