How to improve your cash flow and avoid common problems and causes

Business success isn’t just down to making big profits. You also need a healthy cash flow to keep operating smoothly and growing at pace. After all, without cash to hand, how can you grasp the next opportunity? 

Here are some helpful tips on how to improve cash flow for your business.

Cash flow (or a lack of it) is one of the main reasons why young businesses fail. And it’s such a shame.

Even some of the best business ideas can fall flat because there isn’t enough money to keep it going, let alone growing.

The positive takeaway is that if this rings true, you’re not the only one. Help is out there to improve your cash flow and keep buoyant, starting right here.

What is cash flow?

The term ‘cash flow’ describes the movement of cash into and out of your business.

It’s different from both turnover (which is the total amount of revenue you generate) and profit (which is your revenue minus costs), because cash flow is specifically about the amount of money you have available to spend now.

It also considers money coming in from all sources, including loans and investments, rather than just how much money you get from clients.

The difference between cash flow and profit

If you’re wondering why you can bring in money but still struggle to make ends meet, it’s because cash flow and profit are two different things.

Profit is your revenue minus your costs, whereas cash flow is the money you have available at any one time.

It can also include funds like investments and loans, as well as any of your own cash that you put into your business to keep it going.

Why is cash flow important?

Every business should strive to improve and have positive cash flow.

This means simply that you have more cash coming into the business than going out, so that you always have enough to meet your debts as they fall due (failure to do this can cause cash flow insolvency).

Also, the more positive your cash flow, the more money you have available to make new investments in your business.

Negative cash flow

Negative cash flow means that you have more cash going out than coming in.

This doesn’t necessarily mean your business isn’t profitable, but it does mean you are using up your accessible cash faster than you can replace it.

Positive cash flow

A positive cash flow is important simply because there is so little your business can do without cash to spend.

Everything from buying new stock to paying staff wages and business rates depends on having cash available. Think of cash as your business’s fuel – without fuel flowing in, the engine will stall.

Types of cash flow

There are a few different types of cash flow:

Operating flow

This is the cash you need to keep your day-to-day operations running. It covers the costs of buying goods, paying staff, for the premises etc.

Investing flow

You might also want cash to pump back into your business to take it to its next stage. This could be to buy new equipment, expand your stock and take on or upskill new staff.

Financing flow

This kind of cash flow is all about debt, dividends and equity. It’s the cash you need to pay shareholders and pay off loans.

Problems with cash flow

It’s possible to have a thriving business and yet still have a problem with improving your cash flow.

High turnover and healthy profits are of course great goals to aim for, but if they come at the expense of cash flow you may run into difficulties. 

Many factors can reduce the level of ready cash you have available, such as unexpected costs, late payments from clients, or an overdrawn director's loan account.

As a result your business may find it has no cash with which to settle bills, acquire new stock or pay tax. This is what we mean by a cash flow problem.

Cash flow difficulties can have severe knock-on effects, such as making you late paying tax bills and incurring fines from HMRC.

In the worst cases, they may even result in your business folding despite being highly profitable on paper.

Every business needs to remember that money isn’t money until you have it in your hand.

New and smaller businesses are especially vulnerable to cash flow problems, as the monthly income may be unreliable and may sometimes be lower than your outgoings.

You therefore need a strategy to manage and improve your cash flow to avoid your business becoming insolvent.

Common cash flow problems and how to avoid them

Here are four of the most frequent causes of negative or unreliable cash flow, and solutions for preventing them.

Tight margins

The profits you make from your products may be too low to cover the total cost of delivering your business.

This is a common mistake with new startups that haven’t fully worked out their business model.

When pricing a product, do your best to factor in all the costs of getting it to market, and consider dropping it if you can’t find large enough margins.

Clients who pay late or not at all

Clients will typically try to delay payment for as long as they can – the larger the client, the more they feel they can get away with this.

This can put a great strain on your cash flow, especially if the larger clients account for the bulk of your revenue. With key clients like this, try negotiating early payments in exchange for a small discount.

More serious problems can occur if clients miss deadlines or fail to pay at all.

The best solution here is to prevent it happening, by checking the payment records and creditworthiness of new clients in advance.

In addition, develop strong credit control practices to help you chase and recover bad debts.

Too much stock

If your business is based on you buying in stock or raw materials to sell on, it doesn’t make sense to keep more stockpile than the business can handle within a set timeframe.

Unless you are anticipating a sudden massive order, try to keep only as much stock as you are likely to need before the next delivery window.

This is the principle behind ‘just in time’ (JIT) manufacturing, to avoid tying up lots of cash in stock that merely sits around waiting.

If you need to buy in stock that exceeds your cash flow, trade finance (a form of short-term business credit) can be an option.

Excessive overheads

Your overheads are the expenses that are necessary for keeping the business running, but which don’t relate directly to the business itself.

Examples might be literally ‘keeping a roof over your head’, paying for your IT equipment, heating and lighting bills, employing cleaners etc. Often it’s possible to find savings here.

How do I improve my cash flow?

Keeping your cash flow healthy is a constant mission. These tips are common ways that businesses save money, make money and keep payments coming in on time;

Cost your services properly 

When you first start out, it’s tempting to under price yourself to bring in more business.

Whether you’re underestimating your expertise or the value of your products, or you’re simply trying to lure in customers, low prices can have the opposite effect and harm your cash flow in both the short and long term.

It’s also difficult to increase prices significantly when you start at a low level. Do market research and price yourself competitively. If customers or clients do quibble the price, be ready with reasons why you are different from your competitors.

Or leave wiggle room in your quoted price to come down without injuring your margins.

Offer easy ways to pay

When your aim is to collect money, it doesn’t help if there are payment barriers in place.

Offer flexible payment options by accepting cards, bank transfers, PayPal, Direct Debits and cash (if appropriate for your business). You should also make your payment details easy to find.

Make sure customers are clear on your prices before you hit them with a bill they don’t expect.

And if you send clients invoices, include the bank details so they’re easy to find.

Do your research before you agree to work

No start up wants to turn down business. But what’s the point in spending time and effort on work that you never get paid for?

It can be difficult to know whether a client is or isn’t likely to pay, but a little research can go a long way. If it’s a business, look it up on Companies House to make sure it’s legit and its finances are in order.

An accountant can help you do this digging to make sure you’re not getting involved with a business that’s facing its own cash flow problems.

If in doubt, ask for a deposit

People and businesses that are happy to pay are usually happy to put down a deposit too.

You could request 25% or 50% upfront, or ask them to cover the cost of any materials upfront.

Not only will this ensure you have enough cash to cover immediate outgoings, but it can also help to protect your cash flow should they default later down the line.

Stick to your payment terms

When agreeing work with clients, you should always agree payment terms first with a written up contract.

Without this, it’s much more difficult to chase payments, and you’d hit a wall if you decided to take legal action without hard evidence. Include details on when you’ll invoice them and expect payment, ways they can pay, who you’ll contact for payment and who they should contact with any queries.

With clear payment terms in place, no one can pretend they weren’t sure about the payment. Just remember to stick to your end of the bargain, otherwise they might not stick to theirs.

Monitor, chase and ban

Lots of businesses have online systems to help with keeping track of invoices and payments coming in.

They’re a good way to know where you stand with cash, and they can save you time in looking through spreadsheets trying to find one missed payment.

Ideally, you should be checking this daily, so that you can quickly start to chase a payment when it’s overdue. Keeping an eye on late payments will also help you spot clients who are regularly paying late or not at all.

You might want to consider banning them from your books if they’re causing a headache.

Focus on building relationships

You might feel awkward chasing payments, but if you have a good rapport with the client, it should be much easier.

Not only can you drop the payment into conversation, but they’re also less likely to default if they value your relationship.

Try to keep in regular contact, focus on quality and value, and act on your promises.

Keep an inventory

Unused stock could also start draining your cash, especially if you’re ordering in fresh produce that you end up having to throw away.

Knowing how much to order takes experience, but it starts with keeping note of the amount you regularly order and use.

Tracking this information through an inventory will help you quickly spot when stock is going to waste, enabling you to cut down on unnecessary expenses.

Don’t pay straight away

No one loves debt, but it’s something business owners have to get comfortable with.

If you pay invoices straight away, you might find yourself getting rid of the vital cash you really need.

Holding onto it until other payments come in can really help you keep the cash flowing nicely.

BUT that doesn’t mean you can constantly make payments late. Make sure you stay within the payment terms to avoid burning vital bridges you need to succeed.

Get a professional involved

The tips above are about putting essential cash flow measures in place, but you should never be afraid to ask for help too.

Lots of businesses, big and small, have accountants to take care of all, or lots, of these steps. Because when you run a business, your mind can’t always be on the cash alone.

By getting a good accountant on board, they’ll create regular cash flow forecasts to help you plan better.

They can highlight ways you can make savings, whether that’s slashing your energy bills or finding a cheaper supplier.

And they can chase payments for you, meaning you don’t have to worry about sending those awkward emails. 

How do I calculate my cash flow?

In principle, it’s simple to calculate your cash flow.

Essentially, you just need to work out what your starting balance is for the month, add on how much income you’re expecting and then subtract everything you’ll be spending that month.

The final figure is your net cash flow – i.e. how much cash has come into the business.

If you end up with a negative figure, it’s a warning that you’ll need to find extra cash this month to cover outgoings.

Here is is as a simple equation:

Cash Flow = Balance + Income - Expense

In practice calculating cash flow can be trickier that it sounds, because the key variables (monthly income and outgoings) are not 100 per cent predictable.

You will therefore need to make the best estimates you can (your accountant is probably better at this) and err on the side of caution. Various bookkeeping and accounting software is also available to help you manage cash flow.

What is a cash flow forecast?

A cash flow forecast is an estimate of the business’s cash flow over a future period – say, the next quarter or financial year.

A strong cash flow forecast can be a vital tool for business planning, as it lets you know how much cash is likely to be available to deliver your plans at any given point.

For example, if you are looking to take on new staff over the coming months, or increase your marketing spend, you can feed these figures into your cash flow forecast to see if your finances are likely to cover these additional outgoings.

On the other hand, if there are particular months where business tends to be slow, your forecast can factor these in so you can reduce your expenditure for those periods.

In both cases you can predict potential issues before they arise and avoid cash flow problems.

A particular kind of cash flow forecasting is sometimes called cash flow modelling. A cash flow model is a forecast based on a particular future scenario or range of scenarios.

For example, if you’re trying to decide between two different growth strategies for your business, cash flow models can provide you with forecasts for both scenarios, to make them easier to compare.

Why are cash flow forecasts important?

A good cash flow forecast or model can be key to business success. Not only can you reduce the risk of cash flow problems, but you can also gain the confidence you need to make longer-term plans.

A cash flow forecast need not be just a warning to take care; it can provide reassurance that you will be able to afford your more ambitious business goals, and show you what you need to do to prepare for them.

On the other hand, if you don’t have a good system of tracking your cash flow, planning can become very tricky if not impossible.

It can also make it harder to apply for business loans or attract investors. Solid cash flow records and forecasts are a visible sign that your business is well-run, and can pay for themselves many times over in both the benefits to your business, and the investor confidence that they inspire.

Seek financial advice

We hope you found this article on how to improve cash flow informative.

An accountant (or financial adviser with business expertise) can also help you with cash flow management, forecasting and modelling.