Don’t bankrupt your business by running out of cash
Business don’t go bankrupt because they are making a loss. They go bankrupt because their bank account is empty, and they can’t pay their own bills anymore! If you don’t manage and plan your cashflow you will get a lot of headaches and sleepless nights. You need to manage it!
Today’s article is a bit longer, but please bear with me, as this is an important topic and not discussed nearly enough in my opinion.
In theory managing cashflow is easy. Just make sure more money is coming in than is going out. But in practice this is a lot harder, even for profitable companies. There are several situations in which you might feel you don’t have control. On a rare occasion my business needed to borrow cash from me privately to be able to pay all the bills on time. Because that is the crucial thing here, time. Even a profitable business can go bankrupt on cash problems if the timing of incoming and outgoing payments is at odds. Let’s talk about a few common situations that can cause cash problems.
Supplier bill is due, but client hasn’t paid yet
If you have outsourced a large portion of an order this can be a serious risk. This happened to me recently where I had to pay a supplier more than € 20.000,- and my client was late in paying. Even though I manage my cashflow quite strict a gap of 20k is not something a business can easily cough up. So I had a bit of stress. In the end I had to take a loan of 10k from my private accounts, which I was able to pay back a few days later when the client’s payment came through.
The thing is, I was aware of this risk, I even negotiated with my supplier to pay 34 days after invoice date, while my client would have to pay after 30 days. But those few extra days were not enough as it turned out.
How to prevent this? Number one would be to have a larger buffer, so you can pick up the slack of your clients. Number two, always make sure your clients pay you before you have to pay your supplier. This doesn’t guarantee anything, as the example above shows, but it is perfect in the cases where your clients do pay on time.
Another solution you could consider for larger projects is factoring. Factoring is a process where you “sell” your invoice to an intermediary at a discount to the invoice value. When the client pays, the payment goes to the factoring company. This solution does cost you some margin on the order, but you get paid almost the same day that you send the invoice. I wouldn’t recommend this for all your orders, but for the larger ones or when you are really strapped for cash this can save you. You can read more about factoring on this Wikipedia page:
Client is never going to pay
As soon as you think the client might never pay, go to a collection agency. I experienced this once and although I was hesitant about going to such an agent, it really worked well. Remember, a client that doesn’t pay is not a client. And you don’t want to work with them any more in the future anyway. Put an agent on it and they will sort out everything. Of course, it doesn’t guarantee you will get paid, but it increases the odds a great deal.
If after all that the client still doesn’t pay, for example when it is bankrupt, you will need to take the loss. There is no way around it.
If non-paying clients are abundant in your industry there are a few ways you can increase payment security. The best and most obvious, ask for payment in advance. Preferably 100% but any percentage is better than no advance payment at all.
Second option is to ask for a bank guarantees, or for international trading Letter of Credits. Depending on how they are setup you are at least sure that the clients has the funds to make the payment and often you will get immediate payment when the conditions under the bank guarantee are filled, such as delivery of the goods.
And a third option is insurance. You can insure your invoices against defaults by clients, but its not cheap and the insurer wants you to insure all your invoices, not only the ones that you feel bad about. So this is only an option if this problem occurs frequently. We used to do this in India, as there the legal system is very slow, so suing a business for not paying takes years. An insurance company will help a great deal in putting pressure on a client to pay in case they are late.
Most small business have to pay VAT every three months or every month for larger businesses. For VAT calculations the date of the invoice is used. So, if you are paid (much) later, you would have had to pay the VAT from your own pocket. If you are really strapped for cash, then this can be the deathblow to your business. As a result, some businesses postpone sending invoices just before the VAT cut-off date, but naturally this creates a vicious cycle. Because when you send an invoice later, you also get paid later.
There is no real solution here as you can’t negotiate with the tax department. The only solution is managing your cashflow overall.
Sort of the same as the VAT problem, but typically on a yearly basis. Last years income tax is usually due somewhere in the middle of the current year. You need to plan for this cashflow, as companies did go bankrupt over this payment. Again, negotiating with the tax department is not an option. You need to plan ahead!
To help you manage your cashflow we are developing an online cashflow management program. We are looking for business owners like yourself who can help us by testing it. As a thank you, you can use the tool for free for a whole year. Ready to help us in helping you to manage your cashflow? Leave a comment below and we’ll be in touch.