Guide To Cash Flow, Forecasting & Insolvency

cash flow forecasts and insolvency

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You may have heard the expression ‘cash is king’, which for companies often refers to the importance of cash flow in the overall financial health of a business. Having a strong cash flow and cash reserves can protect a company from the unforeseen. However, not all companies have this luxury.

So what can help a company manage its cash flow more effectively and help protect it from financial difficulties? Furthermore, what measures can a company consider when it is experiencing cash flow issues and potentially facing insolvency?

Cash flow forecasts

For directors, visibility to a company’s cash flow and financial information is fundamental. Ideally, at the click of a button, directors can review income and expenses at any given time and for any historic period. Reviewing a company’s financial information and comparing actual amounts to forecast values is key in understanding any trends and identifying areas which could be improved.

Accounting software has evolved significantly over recent years. In some cases, companies are still yet to fully utilise and benefit from these improvements. Leading software packages offer benefits which can save a business time and ultimately money, leaving directors to focus on a company’s strategic objectives. Cash flow modelling software can also help directors plan ahead and manage future cash flows. It is therefore recommended that companies review their accounting software and consider current market options.

Business life cycle and cash flow

There are five phases of a business’ life cycle:

  1. seed and development
  2. start up
  3. growth and establishment
  4. expansion
  5. maturity and exit

The life cycle is relevant to a company’s cash flow as in the early phases cash flow will be extremely tight and any surplus likely to be reinvested. Having cash flow forecasts in place is vital and constant monitoring of these is strongly recommended. Approximately 60% of UK start-ups fail within the first three years and 20% within just twelve months. Whilst there will be many contributing factors, these statistics reinforce the importance of managing cash flow effectively, particularly in the early phases.

Cash flow problems

So what cash flow problems might a company experience and what measures can be taken to help avoid financial issues?

Inaccurate forecasting

Having a robust business plan and financial forecasts are fundamental components of any business. Failure to anticipate and accurately forecast income and expenses will have a catastrophic impact on a company’s ability to maintain a positive cash flow, particularly in its early phases.

A cash flow forecast will identify which months the company will have a cash deficit, and which months it can expect a surplus. It was also factor in any seasonal variation and calculate how much cash the company requires in a given period. This is particularly important where the company requires funding, especially if funding is to be provided by a bank or financier. The lender will expect any financial forecasts to be watertight and based on logical assumptions.

Cash flow templates and modelling software are readily available. However, obtaining professional assistance from an accountant is encouraged as they will have relevant sector experience which will result in more accurate forecasting.

Profit

A fall in profits or losses will, understandably, have an impact on cash flow. Unless the company has sufficient cash reserves to cover these movements, it will only be a matter of time before the company experiences significant financial issues.

Carrying out a review of all income and expenses to see where savings or improvements can be made will help the company address any issues and improve its financial performance.

The company should also review its pricing and profit margins. Carrying out a market and competitor analysis will also help identify any potential pricing opportunities.

Inventory

For product-based companies, an overinvestment in materials can put a strain on a company’s cash flow. Cash tied up in materials which is not being converted into finished goods and sales quickly can cause a company to suffer additional costs such as storage, insurance and inventory management. The stock may also be at risk of depreciating in value and becoming obsolete.

Over investment in capacity

As a company grows, it will be looking to increase its capacity. However, if this investment is not matched with increased demand and output, the company will be left with increased costs. Timing is everything. Before considering increasing capacity, a company should first review its existing operations to identify any areas where efficiencies can be achieved which unlock additional capacity.

The company should review its staffing requirements and may need to restructure in order to reduce costs.

If demand for the company’s products and/or service fluctuates regularly, then it may be beneficial to utilise a flexible labour source.

A company may also consider outsourcing some of its operations.

Loss of a major customer or revenue stream

Some companies find themselves exposed to a small number of large customers. Where competition is high, there is every chance a customer may seek more favourable terms with another supplier. To mitigate this position, the company should seek to protect is position. This could be by way of bolstering contractual terms or growing its customer base. Adding additional revenue streams will also help to minimise the company’s exposure to the loss of a major customer.

Bad debts

Customers who fail to pay can cause significant cash flow problems, particularly if a company’s revenue is concentrated on a small number of customers. Managing debtors and customer lines of credit help to mitigate a company’s exposure to potential bad debts. Effective credit control is a must if a company is wanting to minimise bad debts and maximise cash flows.

Carrying out customer credit checks is also a good precautionary measure to help protect the company from potential non-payers.

The company should also consider its customer payment terms. If the company is to invest a significant amount of time and/or cost before the customer is invoiced, it should consider a deposit payment structure.

It may also be worthwhile carrying out a cost-benefit analysis regarding trade indemnity insurance.

Incentivising customers to pay early may also help a company’s cash flow and avoid large debtor balances.

Supplier payments

If a company falls behind with its payments to suppliers, enforcement action may follow which could result in a County Court Judgement (“CCJ”) being awarded against the company. A CCJ will have an adverse effect on the company’s credit rating and is likely to lead to further financial issues if not resolved swiftly.

If a supplier obtains a CCJ and it remains unsatisfied, this could lead to enforcement action (i.e. bailiffs) or a winding-up petition. In this scenario, it is strongly recommended that the directors obtain professional advice from an Insolvency Practitioner.

Tax

In terms of liabilities, payments to HM Revenue & Customs (“HMRC”) can be some of the largest cash out flows a company has to make.

VAT tends to be the main cash outflow, particularly if a company reports its VAT on a quarterly basis. It is essential that a company retains sufficient funds to meet this liability. Setting aside funds in a separate deposit account may assist. If a company accounts for its VAT on an invoice basis, customer payment terms should also be reviewed. Extending long payment terms to customers may put a strain on cash flow.

With the implementation of Real Time Information (“RTI”), companies now have a set time to submit payroll information to HMRC and pay over any tax and National Insurance contributions by the 19th of the following month. Arguably, accounting for amounts due to HMRC on a monthly basis helps to stabilise cash flow and these should be factored into the company’s cashflow forecast.

Corporation Tax is a positive sign that a company is making profits. However, as payment to HMRC is not due until 9 months and 1 day after the period end, companies can fail to set aside funds to meet this liability when it falls due. Accurate forecasts and record keeping are a must if a company is to avoid falling into arrears with HMRC. Setting aside funds in a separate deposit account is recommended.

Late payment of tax will result in penalties and fines and eventually legal action being brought against the company. HMRC enforcement action can restrict or stop a company from trading and the issuing of a winding-up petition can be terminal.

If a company has overdue tax liabilities, then agreeing a Time To Pay (“TTP”) arrangement with HMRC may be an option. The directors would need to be satisfied that the company will be able to make these payments in addition to is ongoing commitments. Before considering a TTP arrangement with HMRC, it is strongly recommended that the directors obtain professional advice from an Insolvency Practitioner.

Customer and supplier credit terms

Most companies and suppliers offer credit terms. These can vary so it is important to ensure that these credit terms work for the company. Shorter supplier terms will put additional pressures on a company’s cash flow. It is therefore important that these terms are in synergy or even favourable to the company.

Credit control

It is essential that a company receives its turnover in a timely manner and in-line with its forecasts. There is always a risk of non-payment when a company provides a service or product in advance of payment. Where credit terms are offered, having accurate sales records and a designated credit controller are key if the company is to effectively recover its debtors.

Funding

In order to address any cash flow issues, the directors may be considering additional funding. This may be from the directors or shareholders personally or a lender. Where considering obtaining funding from a lender, there will be various options available, ranging from overdraft facilities to invoice finance. Whilst the company will receive an initial cash injection, the company will be taking on additional debt. It is therefore strongly recommended that directors obtain professional advice from the company’s accountant or financial advisor when considering further funding.

Cash flow and insolvency

Under UK legislation, a company is considered insolvent if it is unable to meet its debts as and when they fall due. If a company is experiencing cash flow issues, it may not necessarily be insolvent as it could be solvent on a balance sheet basis. Whilst a company may have reserves, loses cannot be sustained indefinitely.

Where a company is experiencing cash flow issues and incurring debt, it is strongly recommended that the directors obtain professional advice from a licensed Insolvency Practitioner at the earliest stage. The Insolvency Practitioner will consider all options available with a view to avoiding a formal insolvency process. Generally, the Insolvency Practitioner will consider the following areas:

  • Financial performance
  • Forecasts
  • Assets and liabilities
  • Operations
  • T. Systems
  • Human resourcing
  • Market
  • Re-finance
  • Restructuring the business
  • Funding

When a company enters the ‘zone’ of insolvency, the director’s duties shift from shareholders to protecting the interests of creditors. Asset values must be protected where possible and liabilities minimised. Any continued trading and actions of the directors beyond the ‘zone’ of insolvency must be in the interests of creditors.

Under UK law, directors are generally not liable for company debts and losses. This is by virtue of corporate limited liability. However, where directors have acted improperly or in breach of their duties, then personal liability may arise. If a UK company director concludes or should have concluded that an insolvency process was inevitable and does not then take every step to minimise potential loss to creditors, then personal liability may arise.

Summary

Managing cash flow is a fundamental part of running any business. With so many variables affecting inward and outward flows, investing time and money in managing cash flow is strongly recommended.

There are many options available to directors to strengthen a company’s cash flow. Utilising technological developments may save a business time and money and obtaining professional advice from an accountant could prove invaluable.

When a company is in the ‘zone’ of insolvency, obtaining professional advice from a licensed Insolvency Practitioner at the earliest opportunity will give the company the best chance of overcoming its financial challenges. The Insolvency Practitioner will work with the directors and all relevant stakeholders to achieve the best result. Ideally this will be to turnaround the business.

Contact a professional for cash flow advice

Approved Recovery are a licensed firm of Insolvency Practitioners, providing advisory and turnaround services to small to medium sized businesses. We offer a free initial consultation where we will discuss your situation, the options available and help you determine the best way forward.

Contact us for a free no obligation consultation on 0800 066 2248 or email hello@approved-recovery.co.uk

If you do not have an accountant, our accountancy practice Approved Accounting can help you. Approved Accounting specialises in online accounting solutions as this offers huge time and cost savings, freeing up business owners to focus on the management of their business. We work with a range of businesses in a variety of sectors. No matter if you’re just starting out, run an established business or simply require advice, we can help you.

Contact Approved Accounting for a free no obligation consultation on 01730 823000 or email hello@approved-accouting.co.uk

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Marcus Tout

Marcus Tout

Marcus is a qualified Insolvency Practitioner with a passion for delivering exceptional client service. He's focussed on providing MVL's to small companies across the UK.

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