Introduction to financial management Good financial management includes three essential elements – realistic budgets, up-to-date financial records and healthy cash flow. • Budgets illustrate the predicted income and expenditure of a company or project over a specific period of time, e.g. a twelve-month period. • Financial records and accounts illustrate the actual income and expenditure over that same period of time and what the company owns and owes at the end of it. • Cash flow relates to the activity of the bank account over that same period of time and how well the account can maintain a positive balance.
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All three elements will provide a full and detailed picture of how the business is doing financially and how it is likely to do in the future. They are essential tools in managing the business on a day-to-day basis, providing information to support key decisions, highlighting
potential problems and providing an opportunity to avoid them. They are also powerful tools with which to persuade others to lend or give you money and to show that you have a viable and successful
business.
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This guide focuses on the third element – managing cash and cash flow forecasting.. It provides an introduction to: Managing cash flow Invoicing and chasing payments Cash flow forecasting
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Managing cash flow Most businesses, and particularly small companies just starting up, will experience problems managing cash flow at some time or another. All too often, these problems can cause a business to fold before they are able to correct the problem. As a small business, you need to make sure you are doing everything possible to keep your cash flow healthy (i.e. have money in the bank at all
times).
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There are various ways in which to achieve this, for example: •
Try to secure some initial investment that will tide you over in the first few months.
•
Negotiate good terms with your suppliers e.g. to pay them 30 days from the date of invoice rather than up front.
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•
Arrange to pay large bills e.g. insurance, telephone bills, equipment purchases etc. by monthly instalments over a year.
•
Negotiate good terms with customers e.g. payment on receipt of
invoice, a percentage of fees up front (to cover materials etc.), in instalments. •
Arrange an overdraft facility (using your new cash flow forecast to show the bank when you need it and when you will be able to pay it back) or a long-term loan that may have better interest rates than an overdraft. 6/18
Invoicing and chasing payments Often the reason for experiencing cash flow problems is that customers / clients do not pay you as quickly as you expected. Bearing this in mind, it is very important that you make sure your invoice has everything on it that is needed in order for them to pay you promptly.
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Invoices should always include the following:
•
your name, address and telephone number
•
the date of the invoice and a reference number (to help you with your records)
•
their name, address and contact person
•
details of the work / services provided and fee ‘as agreed’ (quoting a letter or contract issued on a particular date or a purchase order number)
•
terms of payment – e.g. on receipt of the invoice, within 30 days, 50% now and 50% to be invoiced on completion of project etc.
•
details of how to pay – e.g. cheque payable to Mr … at the above address, also payable by BACS to the following account 8/18
It is often worth adding at the bottom ‘Please support small businesses by prompt payment’, a phrase increasingly quoted on invoices and proving effective in pricking consciences! It may seem obvious, but making sure the invoice is typed clearly on
an A4 page (and not handwritten on anything smaller) will guarantee that it is not lost or sent back for being unclear.
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Often the invoice is only produced at the end of the job and the terms are only discussed at this point. This can often be too late. Try to make sure you have negotiated terms of payment at the beginning of a project. Get them in writing and get your invoice in as soon as possible within the terms agreed. Do not take the risk of trying to negotiate when you get paid after the project is complete. You might not be on as good terms with the client as you were at the start of the project (!) and / or you might know that they’ve ended up losing money on the project for other reasons. You do not want your own fee to be affected by any of these potential risks. 10/18
If, once you have done all of the above, you have still not received payment, do not be afraid to phone and ask when you will receive it. You could always suggest you can come in to pick up the cheque from them. Unfortunately, it is the most persistent supplier that will often get paid first. The Better Payment Practice Campaign www.payontime.co.uk provides guidance on how to chase up late payments.
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Cash flow forecasting ‘Cash flow’ describes the activity of your bank account – money coming into the account, money going out of the account and the resulting bank balance.
A cash flow forecast, like the budget, is an estimate of that activity over a specific period of time. It is an extremely useful exercise as it can predict what your bank balance will be at the end of each month and whether you’re going to hit problems if money doesn’t come in when you need it.
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All companies, large and small, will structure their cash flow forecast in the same way – normally covering a twelve-month period (which matches their financial year) and divided into months. Each month will show the opening bank balance (on the first day of the month), the receipts received and payments made during that
month and the resulting / closing bank balance on the last day of the month. That same closing balance will become the opening balance of the following month and so on.
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Receipts refer to monies coming in to the account e.g. grants, donations, fees, sales of work, loans etc. received in the form of cheques or BACS payments into your account. Payments refer to monies going out of the account e.g. project costs, office rent, wages, bank charges etc. paid in the form of cheques, direct debits, bank transfers or petty cash from your account.
An effective way of structuring your cash flow forecast is to use the same headings that you might use in your budget and to make sure it covers the same period. 14/18
In the following example, Company A has produced a cash flow forecast for the first six months of the year. April
May
June
July
Aug
Sept
£6,000 £0 £0 £6,000
£0 £0 £2,000 £2,000
£0 £0 £500 £500
£0 £0 £0 £0
£0 £0 £0 £0
£3,000 £0 £1,000 £4,000
£0
£500
£2,000
£1,000
£500
£1,000
Salaries
£800
£800
£800
£800
£800
£800
Other Overheads
£300
£300
£300
£300
£300
£300
£1,100
£1,600
£3,100
£2,100
£1,600
£2,100
£4,900
£400
-£2,600
-£2,100
-£1,600
£1,900
£0
£4,900
£5,300
£2,700
£600
-£1,000
£4,900
£5,300
£2,700
£600
-£1,000
£900
Receipts: Grants Tutor Fees Consultancy Payments: Project Costs
Net Balance of Funds Opening Bank Balance Closing Bank Balance
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In this example the first three months of the year look fine. However, because Company A know that they won’t get paid anything more until September, the forecast shows them to be in overdraft at the end of August. This is not good unless they have arranged an overdraft with the bank. Otherwise, they may be incurring bank charges, cheques may start bouncing and they won’t be able to get any more money out of the bank until something else comes in, possibly for a whole month. However, by producing a cash flow forecast like this, Company A can now predict they could have a problem and hopefully have sufficient time to avoid it 16/18
A forecast that highlights such problems can give you an opportunity to act. It is an extremely useful exercise and often a standard report used to present to others. Senior management, the board of directors, funders and lenders will often want to see a cash flow forecast to be reassured that the company is not going to encounter any problems over the next twelve months. Similarly, you might want to present them with a cash flow forecast to demonstrate exactly when you will need their help.
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Next steps For further information on this subject, please refer to the following resources: Budgets Guide Keeping Financial Records Guide Cash Flow Template - an MS Excel workbook with cash
flow, profit and loss, and balance worksheets
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Disclaimer: Cultural Enterprise Office is not responsible for any advice or information provided by any external organisation referenced in this document.