Cash flow for small businesses: what it means and how to manage it.

What cash flow means

Cash flow is the timing of money. Cash comes in when customers pay you, when you take out a loan or when the owners put money in. Cash goes out when you pay suppliers, staff, rent, tax and loan repayments.

Take the cash in for a period, subtract the cash out, and you have your net cash flow for that period. If more came in than went out, cash flow was positive. If more went out, it was negative and your bank balance fell.

One negative month is not a crisis on its own. The problem comes when the balance runs low just as a large bill falls due, and there is nothing left to pay it with.

Why cash flow is not the same as profit

Profit is what you earned in a period. Cash flow is what actually landed in, and left, the bank. The two drift apart for a few ordinary reasons:

• Customers pay later. A sale counts towards profit when you invoice it, but the cash may not arrive for weeks.
• Stock ties up money. You pay for goods before you sell them, so cash leaves well before the sale comes in.
• Loan repayments are not costs. Repaying the amount you borrowed reduces your cash but does not reduce your profit.
• Equipment is spread out. A large purchase leaves the bank in one go, while the accounts may spread its cost over several years.
• Some money is not yours. If you are VAT registered, the VAT you add to your sales belongs to HMRC. It sits in your account until the return is due.

Sole traders and partnerships can usually choose how to record income. GOV.UK describes the cash basis as recording income or expenses only when you receive money or pay a bill. Traditional accounting records them by the date you invoiced or were billed. Limited companies cannot use the cash basis. Whichever method you use for tax, you still need to watch the real bank balance.

Where cash flow problems usually start

Most cash squeezes come from a small number of causes:

• Invoices sent late, or not sent at all, so payment is late too
• A few customers who pay slowly and make up a large share of sales
• Tax bills that arrive in one lump after months of trading
• Growth, where you pay for staff and materials before the extra sales are paid for
• Seasonal trade, with quiet months that still carry full overheads
• Books that are months behind, so nobody can see the problem coming

The last point makes the others worse. If the bookkeeping is up to date, a slow payer or a looming bill shows up weeks before it hurts.

The tax dates that hit your bank balance

Tax is often the largest single payment a small business makes. Knowing the dates lets you set money aside in good time.

VAT

Returns are usually quarterly. The deadline to file and to pay is usually one calendar month and 7 days after the end of the period. The money must reach HMRC by that date, even if it falls on a weekend or bank holiday.

Smaller businesses can ask to use the VAT Cash Accounting Scheme if their VAT taxable turnover is £1.35 million or less. Under it you pay VAT on sales when your customers pay you, and reclaim VAT on purchases when you have paid your supplier. That can help if customers pay slowly.

PAYE for employers

If you run a payroll, the tax and National Insurance you deduct is paid to HMRC by the 22nd of the next tax month, or by the 22nd after the end of the quarter if you pay quarterly. A cheque sent by post must reach HMRC by the 19th. Recruitment agencies feel this sharply, because they pay workers for hours before the client has paid for them.

Corporation Tax

A limited company with taxable profits up to £1.5 million must pay its Corporation Tax 9 months and 1 day after the end of its accounting period. Companies with profits above that pay in instalments. Because the bill comes so long after the profit was made, it is easy to spend the money in the meantime.

Self Assessment

Sole traders and partners pay Income Tax through Self Assessment. Many also make payments on account, which are advance payments towards the next tax bill. Each one is half of the tax you owed last year, and they are due by 31 January and 31 July. Any balancing payment is due by 31 January the following year.

You do not have to make payments on account if last year's tax was less than £1,000, or if you paid more than 80% of the tax you owed outside Self Assessment. This means 31 January can bring a balancing payment and a payment on account due on the same day.

How to build a simple cash flow forecast

A forecast is a month-by-month estimate of the money you expect to come in and go out. It does not need special software. A spreadsheet is enough.

• Start with today's bank balance. Use the real figure, not what the accounts say should be there.
• List expected receipts by month. Base them on when customers actually tend to pay, not on the invoice date.
• List expected payments by month. Include wages, rent, suppliers, loan repayments, subscriptions and drawings or dividends.
• Add the tax dates. Put VAT, PAYE, Corporation Tax or Self Assessment in the month the money leaves.
• Work out each month's closing balance. Opening balance plus receipts, minus payments. That becomes next month's opening balance.
• Update it regularly. Replace estimates with real figures as each month ends, and roll the forecast forward.

Look for any month where the closing balance goes below zero, or below the cushion you want to keep. That is the month to act on now.

A worked example

Practical ways to improve cash flow

Get paid sooner

• Invoice as soon as the work is done or the goods are delivered
• Agree clear payment terms in writing before you start
• Ask for deposits or stage payments on larger jobs
• Make it easy to pay, with bank details on every invoice
• Chase overdue invoices on a fixed routine, not when you remember

Know your rights on late payment

For business to business sales, GOV.UK says a payment becomes late 30 days after the customer gets the invoice, or after you deliver the goods or service if that is later, where no other date was agreed. You can then claim statutory interest at 8% plus the Bank of England base rate.

You can also claim a fixed sum towards recovery costs: £40 for a debt up to £999.99, £70 for £1,000 to £9,999.99, and £100 for £10,000 or more.

Control what goes out

• Ask suppliers for longer terms, and pay on the due date rather than early
• Keep stock levels in line with what actually sells
• Review subscriptions and contracts you no longer use
• Move tax money to a separate account each month, so it is not spent by accident
• Time drawings and dividends around the forecast, not just the profit figure

Why up-to-date books make cash flow easier

A forecast is only as reliable as the figures behind it. If the bank feed is reconciled, sales invoices are matched to payments and bills are entered as they arrive, you can see who owes you money and what you owe, today.

That is the point of daily bookkeeping. Overdue invoices stand out while they are still easy to chase, missing receipts are followed up, and the tax you will owe is visible long before the deadline. A monthly summary then gives you a clear picture to plan from.