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Cash flow risk for businesses – what to look out for and how to minimise it

There are many areas of risk for any business, such as, cash flow risk, operational risk, personnel risk, loss of data, loss of infrastructure, health & safety, bad debts, competition – the list is quite lengthy! 

What I’ll focus on here is poor cash flow or deteriorating cash flow, which is especially prevalent for new businesses or expanding businesses.

1.CashFlow

Cash flow risk for new businesses

Forming a business plan and cash flow statement at the start of any business and monitoring it on an ongoing basis gives a good idea of whether the business has a chance for success or not.  Most businesses fail within the first 3 years and so a sound business plan and cash flow are vital in order to prevent failure. Depending on the type of business there may be capital expenditure up front and set-up/legal costs which will all have to be paid before any income is earned so most businesses will start with negative cash flow. This negative cash flow means that financing will need to be put in place for almost all new businesses, this may come from financing from the equity owners, from banks in the form of loans and/or overdrafts and from finance companies such as leasing assets.  Most if not all of the financiers will require visibility of a cash flow projection before any funding is considered to mitigate their risk.

Cash flow risk for expanding businesses

Most people think “great, if a business is expanding then it must be profitable and hence must have lots of cash” – right?  Well, possibly but it is also another risky time for the business and may put the company into a deteriorating cash flow position. As an example let’s say your manufacturing company is growing rapidly (@ 25% per month), you typically buy materials and produce your products over a 2 month period and then on sale it takes a further month to collect the debt making a 25% mark-up in the process. How does the cash flow look?

Month

1

2

3

4

5

6

Purchases £

-100

-125

-156

-195

-244

-305

Sales £

125

156

195

244

Net Outflow £

-100

-125

-31

-39

-49

-61

Cumulative Outflow £

-100

-225

-256

-295

-344

-405

 

So over the course of 6-8 months the company will be profitable as all sales are marked-up by 25% but as you can see the cumulative cash outflow is getting greater and so could put pressure on the companies financing i.e. requiring higher overdraft limits/loans or alternative financing. If the bank or financing company is not willing to finance the extra outflow then this could put the company in jeopardy and so presents a huge risk for the ongoing viability of the business.

How to minimise cash flow risk for your business

Good planning and monitoring of the plan should highlight where risks may occur well in advance of them actually occurring.  In the above a financial plan and cash flow (for 1-3 years) would show what the maximum funding might be and this could then be sourced in advance of the problem.

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