Here is a scenario familiar to many entrepreneurs – the sales are booming and the business is growing rapidly, but suddenly, when asked for payment by a creditor, you realise that you simply don’t have any cash. What has gone wrong?
This is the result of a cash flow gap, one of the most common problems that a business can face. In order to solve it, you must first understand why they occur, and what you can do when you find yourself in one. Here is everything you need to know about cash flow gaps and their solutions.
What is a cash flow gap?
Cash flow gaps occur when your cash inflows and outflows don’t line up – for example, you purchase stock and immediately pay your supplier, but it takes several days for you to sell it to a customer. During those few days you have no money back from your purchase, and this period is the gap in your cash flow. They can be caused by a variety of reasons, such as late payments from clients or changes in the market.
Normally these cash flow gaps are easily managed by simply having enough money set aside in preparation. However, if your capital is tied up due to business expansion, then cash flow gaps can quickly become problematic if they coincide with payment deadlines. In extreme cases, cash flow gaps can even cause an otherwise profitable business to go bankrupt.
How to fix a cash flow gap
There are a few short-term solutions which can help a cash flow gap; they include but not limited to: selling your account receivables to factoring companies for cash, borrowing additional cash or using an overdraft, delaying payments to your suppliers, incentivising quicker payment from your customers, and temporarily reducing the salaries of your staff.
Invoice factoring, meaning a business owner sells its invoices to a financial company (a factor) at a discount for immediate cash, is a common way to improve the business’s cash flow. How it works is simple – you sell the invoices to a factor and receive a percentage (usually up to 80%) of the value of the invoices instantly. When the invoices are due, the factor will contact the customers for full payment and upon receiving it, the factor will pay you the remaining balance after deducting factoring service and administration fees. In this process, your customers are made aware of the factoring arrangement.
Invoice discounting is similar to invoice factoring, but during the process of invoice discounting, your customers are not aware of the involvement of the factor, allowing you to sell the invoices and maintain a good relationship with your customers.
Long-term strategies to combat cash flow gaps include but not limited to: renting out or liquidating company assets, purchasing only quick-moving stock, limiting stock, and using a cash flow forecast to avoid overtrading.
Having extra stock is often one of the reasons why businesses are strapped for cash. To properly manage your inventory, look very closely at your order history to identify quick-moving stock and pick out periods in which you can keep minimal inventory on hand while waiting for your next order.
Creating an honest cash flow forecast and using it to track your progress can also help tremendously. Keep a look-out for seemingly unrelated events that will have an impact on your business. For example, during a prolonged hot summer, residents across London tend to stay home as opposed to going out. If you’re relying on customers to walk into your shop and the warm weather is likely to affect your business, then make a plan in your forecast and adjust it accordingly. Other events that may also have an impact on your cash flow include currency exchange rates, bank charges and government policy.
Contact Berley for assistance
Cash really is king, as without this fluid capital your business is at risk. If you would like to understand more about cash, cash flow and cash flow gaps, then speak to one of our small business accountants in London today.
For years, we have helped many small businesses across London to strengthen their cash flow management and mitigate the risks associated with cash flow gaps, and we can help you too. To find out more about us and our audit and accountancy services, call us on 020 7788 8261 or get in touch using our Online Form.
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