Why cash flow is critical in your first year of trading

In 2012, 400,000 new businesses were set up, according to the BIS. Unfortunately, two thirds won’t survive their first year. For entrepreneurs in the UK, these statistics are daunting, and they prove how difficult it is to build something from nothing.

There are many reasons for failure. Arguably, many businesses are built on poor ideas, or fail to do adequate research. Some entrepreneurs take on too much, and run out of steam.

But the biggest reason for failure is a lack of funding, and that can happen despite a healthy profit. If expenditure is high, credit control sloppy, and clients less than diligent with their payments, entrepreneurs may fall foul of cash flow problems that will whip the rug from under their feet.

What is cash flow?

In business, cash flow is the art of managing payments and expenditure effectively. Profits are important, but cash flow a matter of good timing. Each month, the business needs to be bringing in enough money to pay its bills.

It’s important not to underestimate cash flow as a factor in business success. According to Simply Cash Flow, 80 per cent of SMEs that failed in the first year had failed because of cash flow problems. Yet only 28 per cent of SMEs named cash flow as the biggest threat to their survival.

Common cash flow mistakes

In its first year, a business can fall foul of all kinds of payment problems. The end result is an interruption to its cash flow, meaning payments don’t come in as quickly as expected.

Typical reasons for this include:

• Failing to invoice clients quickly enough; for large projects, invoices should be raised monthly, rather than being raised at the end of the project
• Failing to take deposits for work, in order to cover initial expenses
• Underestimating the amount of time it takes for a client to pay their bill

The latter can be crippling for a startup. When small businesses are invited to supply goods and services for large companies, this should be a key growth factor, but SMEs struggle to negotiate favourable terms. It’s not uncommon for a large company to impose a holding period on an invoice, on top of a long payment term. This can result in payments being delayed by several months.

Action points

To protect your business from cash flow disaster, put measures in place to protect it:

• Avoid spending large amounts of money too soon
• If you do need to buy something, spread the cost with monthly payments
• Where possible, opt for subscriptions over one-off spends
• Be firm when collecting unpaid invoices
• If a client stops paying, don’t do any more work for them
• Make sure you have agreed a payment arrangement that works for you

If you’ve hit crisis point, invoice factoring can help you to release unpaid funds. But make sure you have a reasonable cash flow strategy, even if you borrow elsewhere, since continued credit can be a downwards cycle.