The Credit Crunch III: Business cashflow

At the best of times cashflow is vital to the wellbeing of a business. When cash is under pressure, as it is in the current credit crunch, ensuring that you are paid, and paid on time, is even more important. Key to this is maintaining a strict financial management policy.

Cashflow forecasting

One way of making sure a business has as much control as possible over the money that moves in and out of its bank account is to put together a cashflow forecast.

A cashflow forecast works by charting how much money is to be paid in to a business over a fixed period of time and how much money the business will pay out during the same period.

The fixed period covered by a cashflow forecast can vary from a quarter to an entire year. It is usually divided into smaller sub-periods such as months or weeks or even days. The forecast will show: monies paid in; monies paid out; the difference between the two; the bank balance at the start of the period; and the bank balance at the close of the period. Forecasts usually include an estimate of the amounts of cash a business expects to receive and pay out as well as the actual amounts.

The advantage of a cashflow forecast is that it provides a business with a useful way of anticipating any downturns in its cash balance.

Credit control

The principal cause of cashflow problems is late payment. In giving a customer credit, a business is effectively offering them a loan on which no interest is charged. Clearly, the sooner that invoices are settled, the sooner the business can use the money to re-invest in itself.

Matters are made worse if a business is having to borrow – say through an overdraft – in order to cover overdue payments; not only is the bad debt freezing much needed capital but it is actually costing the firm money.

The priority is to set up a credit control system; that is, a system of checks and procedures that optimises the chances of being paid and of being paid on time.

Customer credit checks

While new customers are always welcome, it is important that a business is sure that they are capable of paying for the goods or services they have ordered. If a business has any doubts about a customer’s ability to pay, then it is worthwhile carrying out a credit check first.

Most new, and viable, customers will be happy to complete a credit application preliminary to delivery of goods or services. This should include, among other things, the level of credit that is being given, references from other businesses that have had dealings with the customer, and permission for the business to ask for bank and credit references.

A business can make follow-up checks if their concerns run deeper, taking up bank references and requesting information from other suppliers about the customer’s payment history. It might pay to commission a report from a credit reference agency. Two well respected credit agencies are:

Experian at http://www.experian.co.uk/

Equifax at http://www.equifax.co.uk/

They will check that customers are who they say they are and that they have the means to pay for the goods or service. The agency will also recommend a credit limit for individual customers. Other official agencies can help too. Companies House will keep records of the accounts of limited companies, and these are available for checking.

Problems with existing customers

It is not always easy, at least at first, to tell if an existing customer is experiencing financial problems. There are, however, some early, telltale signs to look out for.

These include an unexpected change in payment timings. A good customer may always have settled their invoices on time; now they are delaying payment. Frequent errors on cheques – the wrong date, absence of signature – may be simple mistakes; but they may be a deliberate way of masking an inability to pay. Constant querying of invoices or promises that the cheque is in the post or refusals to take phone calls may be other indications of problems.

If payment patterns deteriorate, you may want to run a credit check.

Preventing late payments

Impossible though it is to get every customer or client to pay right on time, there are certain steps a business can take at least to minimise the accumulation of too many overdue invoices.

Credit terms

The first step is for a business to make sure that its credit terms are clear and easy to understand. If the time limit for payment is 30 days, then customers should be aware of this. Detailing and discussing terms and conditions before a sale is made will help avoid misunderstandings or difficulties later on.

Some businesses consider it worthwhile to operate a sliding scale of payment terms as an incentive to customers. For example, any bills that are settled within a week are entitled to a small discount, whereas those that exceed, say, the 30-day limit could forfeit their chance to cash in on the discount for the following three months.

Your terms may also offer customers alternative methods of payment, particularly electronic methods such as BACS. Electronic payment can stop the risk of cheques going missing in the post.

Invoices

The next step is to make sure that the invoices themselves don’t become excuses for non-payment. For this reason they ought to be paragons of clarity. They should carry both the name and address of the business and the customer. They should be dated accurately and clearly. Just as prominent should be the date by which payment is due. Invoices should quote any purchase order raised and should describe the specific nature of the service, work or product. The amount charged should be for the correct and agreed price, and the VAT, if any, should tally.

As soon as the goods have been delivered or the project completed, an invoice should be raised and sent at once.

Payment timetables

Businesses should set customers, and themselves, a strict payment timetable and should keep to it. Reminder letters need to be sent and chase-up phone calls made according to the timetable.

Under the Late Payment of Commercial Debts (Interest) Act 1998, firms have the legal right to charge interest up to 8 per cent above the existing base rate, fixed for two six-month periods each year, on overdue invoices. Many businesses, not unnaturally, are wary of penalising customers and clients in this way for fear of jeopardising future contracts, so you may want to assess your relationship with the customer before applying the charge.

Lastly, when chasing late payments, it is always best to target the largest outstanding amounts as well as the oldest debts. If things get so bad that a business is forced to take remedial measures, then it is important to carry out the action of which the non-paying customer has been warned. Failure to do so will simply encourage the belief that the business is not serious about getting hold of its money.

Payment collection

Regrettably, in some cases there will come a point when it is clear that no amount of polite coaxing or pleasant reminders will persuade the customer of the need to settle the invoice. Then it might become necessary to involve a debt collection agency (they will charge a fee as a percentage of the outstanding sum) to secure payment.

Other payment collection options open to a business include credit insurance, factoring and retention of title.

For a premium, credit insurers will cover the risk of incurring bad debts. Factoring companies provide finance against outstanding invoices and will assume responsibility for collecting the overdue amounts. In certain circumstances, retention of title allows a business to reclaim, as its own property, any goods that a customer has failed to pay for.

Running a business is demanding and time-consuming, no more so than in the difficult conditions the credit crunch has brought. If you would like professional help and guidance in managing your cashflow, please don’t hesitate to contact us.