Cash flow for small businesses: why profitable firms still run out of money

TUREFF• •0

A business can be profitable on paper and still fail because it cannot pay its bills this month. Profit measures whether you earn more than you spend over a period. Cash flow measures whether money is in the bank when you need it. The two drift apart all the time, and the gap is where many small firms get into trouble.

Why profit and cash differ

Customers pay late. You record a sale when you invoice, but the money may arrive thirty, sixty or ninety days later.
You pay suppliers first. Stock, materials and subcontractors often need paying before the customer pays you.
Stock ties up money. Goods on a shelf are an asset in your accounts but not cash you can spend.
Growth eats cash. A big new order means buying more materials and paying more staff before any of it is paid for.
Loan repayments and equipment reduce cash immediately but are not treated as day-to-day costs in the same way in your profit figures.
Tax bills arrive later, based on profit you may already have spent.
Seasonal swings mean a strong summer can be followed by a thin winter with the same fixed costs.

Build a simple cash flow forecast

A cash flow forecast is a month-by-month table of money in and money out. It does not need to be clever.

Start with today's bank balance.
List expected receipts in the month you expect the money to arrive, not the month you send the invoice.
List all payments: rent, wages, suppliers, loan repayments, subscriptions, tax, your own drawings.
Calculate the closing balance for each month and carry it forward.
Look for the lowest point. That is the month you need to plan for.

Forecast at least twelve months ahead, and keep a more detailed week-by-week view for the next couple of months if money is tight. Update it with real figures every month.

Speed up money coming in

Invoice immediately when work is done, not at the end of the month.
Set clear payment terms and put the due date on every invoice.
Take deposits or staged payments on larger jobs.
Make paying easy: card payments, bank transfer details on the invoice, payment links.
Chase politely and promptly. A reminder the day after the due date works better than one a month later.
Check new customers before offering credit on large orders.
In the UK there is a legal right to claim interest and compensation on late commercial payments; similar rules exist elsewhere. Know your rights even if you rarely use them.

Slow down money going out, fairly

Negotiate payment terms with suppliers rather than simply paying late, which damages relationships.
Buy stock in smaller, more frequent batches if the price difference is small.
Lease or rent equipment where it makes sense, rather than paying everything upfront.
Review subscriptions and recurring charges every few months.

Set money aside for tax

Open a separate savings account and move a percentage of every payment into it for income tax, corporation tax or VAT as applies to you. Ask an accountant what percentage suits your situation. A surprise tax bill is one of the commonest cash shocks for a new business.

Keep a buffer

Aim to hold enough cash to cover a few months of fixed costs. Build it gradually from good months. A buffer turns a late-paying customer from a crisis into an inconvenience.

Warning signs

You regularly rely on an overdraft or credit card to pay wages or rent.
You are taking on work at a loss just to bring cash in.
Customers who used to pay on time are getting slower.
You do not know your bank balance without looking.

If you see these, act early. Talk to your accountant, your bank and, if needed, free business debt advice services. Options are far wider before a crisis than during one.

Financing gaps

Overdrafts, short-term loans and invoice finance can bridge timing gaps, but they cost money and add risk. Understand the full cost and terms before signing, and do not use short-term borrowing to cover a business that is not profitable underneath. Have you been caught out by cash flow, and what helped? Share your experience or questions in the comments.