According to various credit and small business surveys over the past two years, between 30 per cent and 50 per cent of SMEs say they are struggling to pay bills despite being profitable on paper.
The reason usually comes down to working capital.
What is working capital?
Put simply, working capital is the funds you have to meet your day-to-day needs.
It can be measured by adding your inventory days (how long it takes to convert raw materials into products) to your receivable days (how long customers take to pay you) and subtracting your payable days (how long it takes you to pay your suppliers).
The longer it takes to make and sell your goods, and the longer you wait to see cash from customers, the more impact that time gap has on a business.
How can you improve your working capital?
There are a few levers you can pull to try and improve your working capital.
Review the credit limits you have in place with suppliers and customers and consider the terms - accepting shorter payment terms to suppliers while giving customers longer to pay has an adverse effect on working capital.
Stay on top of bad payers early, and consider checking the credit rating with any significant customer orders before engaging.
It’s also important to keep an eye on your own business - keeping a firm grip on stock levels and considering loans or invoice factoring to bridge any difficult gaps.
Cash flow
Every business has its peaks and troughs, and cash flow rarely runs evenly across the year.
Every business should consider the minimum it needs to operate monthly and always keep a reserve to deal with any fluctuations - keep the whole year in mind, particularly when enjoying a peak.
Holding too much cash
While certainly a good problem to have, it is possible for a business to hold too much cash.
Once sensible reserves have been factored, idle cash could be working harder if it is invested in new equipment or expanding operations.
It could also be used to return funds to shareholders, or make further pension contributions - which is more tax efficient.
There are also low-risk savings accounts for businesses or other forms of investments to consider - though proper advice should be sought to ensure you still have access and do not risk tying funds up too tightly.
Tax
There are also the tax implications to consider when holding onto a lot of cash.
If you are looking at selling the business, excessive cash can impact your Business Asset Disposal Relief (BADR).
To qualify for BADR, a business needs to be substantially a trading company, and large cash reserves not required for trading may be classed as investment activity and could therefore limit the tax relief available.
Owners would need to demonstrate the purpose for holding excess cash, such as planned capital purchases.
Ultimately, the best advice for business owners is to always review working capital requirements, identify reasonable levels of cash to hold and consider what might be the best use of capital for long-term goals.
Scott Harris is the director of Cwmbran-based accountants and tax advisors, Green & Co, and an ACCA-qualified accountant.
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