Business tips for weathering a crisis and the importance of cashflow management
To be able to achieve its goals and make a profit for its owners and shareholders, a company must be able to maintain an adequate cash flow. Cash is the lifeblood of a company, without it, no visions can be realised. It’s also the key to being able to weather a crisis.
Crisis events – such as an economic downturn, the failure of a key customer or supplier, a pandemic – have a way of stress testing a company’s financial position, particularly its cash position. So what are some of the best ways to build and maintain a healthy working flow of cash?
Most businesses in the UK have experienced issues with customer late payments and the statistics around this (shared below) are troublesome for many business owners. But, if you combine the late payment issue with a general crisis, such as the pandemic we have experienced, problems can mount up quickly, even for companies with a relatively strong cash position.
Once the crisis is over, any government support a business may have received will only have delayed problems if the business still can’t rely on a healthy cash flow.
Crises that affect an industry as a whole can mean that your normal cash resource – receivables – become very unreliable. Most businesses are used to chasing payments, but when those payments start to dry up because the clients concerned are going into receivership, you will have to rely on your own financial strength, and that’s where foresight and planning come in.
Preventing a crisis is better than trying to cure one, so here are a few points to consider that may help minimise the risks of suppliers and customers becoming a problem for business and impacting your operating capabilities and cash flow in the future.
Some of the key questions we look to answer in this article include:
- “How do you survive a business crisis?”
- “Who do you manage cash flow in a crisis?”
- “How can a cash flow crisis be avoided”
As specialist small business accountants, Tax agility has advised and assisted many small business through troubled times. Read on to explore the advice and tips we have given our clients over the years.
5 simple due diligence checks to help protect your business against preventable crises
The following five checks are basic due diligence points many businesses often fail to conduct. Also, these checks aren’t something to be done once when first creating a relationship with a new supplier or client; it is good practice to keep an eye on the fortunes of those you work with on an ongoing basis.
1. Credit check
Knowing how good a company you’re about to work with is at paying their bills, is just sound practice. The good news is that unlike personal credit scores, credit scores for businesses are publicly available through credit reference agencies. In the UK, these are: Experian, Equifax and TransUnion.
2. Company House check
Your second stop is Company House. Take a look and check the following:
- The type of business accounts. Beware of ‘micro accounts’ from smaller companies (with turnover less than £632k or have balance sheet less than £316k). There is nothing wrong with being small and agile, provided that they can weather the financial storms like bigger competitors and have a good chance to pay you on time.
- When were they incorporated? If within the last 21 months, they don’t need to have filed any accounts yet, so you’re going to dig a little deeper into the directors backgrounds.
- The latest set of accounts. These are usually up to 9 months out of date, but can still give you an idea where the business is heading. Also, you can often see just what is on the balance sheet and how much debt and creditors they carry that may make them susceptible in the future if the ‘winds of fortune’ change.
- Have they been filing regularly and on-time?
- How much cash do they have on hand? This indicates their abilities to pay current creditor liabilities, and gives an insight into their cash practices.
- Look carefully at the company that you’ve been asked to invoice. Some companies are set up as shells or holding companies. While legitimate, they can sometimes hide poor intent. Holding companies are often asset protection strategies used to limit liability in a business structure. The problem you then have is that any claim you make is likely against a company that has no real assets, leaving you high and dry. Make sure that the company you are working for and the company you are billing are the same entity.
- Check who the directors are and what other businesses they’re involved with. This is a good way of checking the performance history of a director. How many businesses do they run? How well are those businesses doing compared with the one you work with?
3. An industry view
Get an appreciation for how the firm is engaging with its audience. These days, the internet is buzzing with information, particularly on social media. Check out:
- What are other people saying about your potential ‘partner’?
- Who are their clients and likely suppliers and how are they doing?
- How much positivity or negativity surrounds them?
4. Check the review sites
The internet is packed full of useful information, so search for reviews on your client or supplier. There may be review sites for companies in your specific business area. It doesn’t take a lot of effort to do and may reveal something valuable about them.
5. Ask around
You may know other people who do business with your client or supplier. Ask around to get an appreciation for the experiences other people have had with them.
Some late payment statistics
There are some 5.7 million SME’s in the UK (as of 2018). These account for over 98% of all businesses.
78% of these businesses are owed money and are on average waiting at least one month over their greed payment terms for payment.
40% of the companies owed money claim that large businesses are the worst offenders.
34% of SME business owners report that they have to rely on overdrafts to help make ends meet because of late payments.
43% of SMEs rack up around £4.4 billion in costs associated with chasing late payments.
11% of SMEs experiencing late payment difficulties end up employing debt collectors to chase payments.
14% (1 in 7) of small business owners have been unable to pay employees because of late payments.
38% of small business owners have been unable to satisfy debts due to late payment cash flow issues.
(sources: Bacs, Intuit, ONS)
Why is cashflow so important?
Cash is the lifeblood of a business. Without cash you can’t grow your business, and you can’t pay your employees or your suppliers. After a while, you’ll end up with a bad credit report which will bring on even more pain, especially if you need financing, as you’ll be considered a higher risk and will likely end up paying higher interest rates, or worse, not getting the loans you so desperately need. So, cash really is king.
TaxAgility Accountants offer it’s clients cloud based accounting services, such as Xero, that make day-to-day cash flow management and forecasting a simple affair.
How much cash should you keep in a company?
It’s quite normal to hear shareholders saying that keeping large amounts of money in a company is a waste of investment opportunity. The question though, is how much is it prudent to keep?
This really comes down to the operational characteristics of your business and its markets. For instance:
- You have a good feel for how long it generally takes for people to pay you.
- What your ‘burn rate’ is – i.e., your monthly cost base, the essentials you have to pay for.
- How much you need to maintain stocks of products or materials for sales fulfilment or manufacturing.
- At the end of the day, it’s up to you, but there are some rules of thumb more seasoned business owners stick to. For instance; keep enough cash in the business, at all times, to keep the company afloat if there’s no income for three to six months.
Do a cash flow projection
If you know your burn rate, and likely payment dates for your payables and your receivables, then, along with your current cash balance, you can perform a cash flow projection. This is a little bit of analysis that takes a set of assumptions and calculates how much cash you’ll have to work with at a later date. It will also help you understand at what points in the coming months your cash situation is at its weakest. How accurate your forecast is depends upon how accurate the data is you put in.
Cashflow planning and projection is definitely something the team at TaxAgility can help you with. So why struggle? Call us today on 020 8108 0090.
A cash flow forecast also allows you to do a little ‘what-if’ analysis. For instance: What if a significant payment isn’t made to you on time or by a certain date, what impact will that have on your ability to pay your bills? The cash flow analysis is a critical part of running your finances proficiently. While you’re doing this, calculate your current break even point – what needs to come in to cover what goes out – basic month to month profitability.
Cash flow forecasts are also essential if your business is looking to grow, and you need to use your cash at strategic points in time – will you have the money you need? How much can you take out and commit to a project and over what period of time?
Cashflow management in a crisis
There’s one certainty in business and that’s uncertainty. Circumstances change, which can be a good thing, provided you have prepared for it, such as naturally evolving market conditions, maturing client/supplier relationships, cost of materials and key services, etc. Sometimes though, businesses can be caught off guard, such as what happened in the banking crisis of 2008, unforeseen aspects of Brexit, or the recent coronavirus pandemic.
Forget about profit – for now
No matter what the situation, cash is always king. Without it your business won’t survive. In times of crisis, forget about profit. Some believe that profit is the number one priority in business. It’s obviously essentially that a business makes a profit at some point, else why be in business? But, underpinning a business’s ability to make a profit is working capital, the money that keeps the gears in the company turning.
Crisis review
“Facing down the barrel of a gun”, is how some business owners describe the impact of the coronavirus pandemic. Without a regular flow of cash coming in, even with assistance from other areas, some businesses are only delaying the inevitable, as they must still have cash once a crisis is over to be able to recover.
However, not all crises are business-wide like a banking crash or global pandemic, they may be as a result of a crisis within a specific industry or just your company.
Examples may include issues such as:
- Raw materials shortages because of sudden import restrictions.
- Export issues caused by shipping issues (container shortages), such as happened with Brexit.
- Sudden changes in currency exchange rates impacting profitability in other countries.
- Changes in government regulations, such as the recent VAT rule changes in the construction industry that will impact those who rely on VAT collected as a form of cashflow.
- The loss of significant personal affecting critical skill needs.
- The loss of a major client revenue affecting cash flow.
The essential thing to do in any crisis is to urgently review your cash flow forecasts. Ideally, at some point you may have conducted a ‘what-if’ analysis and already know the minimums under which your business can function relatively normally. Now it’s time now to start looking at the areas you can make cuts.
Here are a few things you can do:
1. Get a grip on your business environment
- Golden rule: Don’t panic. It’s especially important to those around you to see that the company’s leader is cool under pressure and reassuring. The last thing you want is to instil panic in your work force. However, people are naturally going to worry and likely have questions about their future, so prepare for that.
- Don’t overreact. Decisions you make now will likely impact your business for years to come. The measures you take now should be calculated and step-by-step, not knee-jerk.
- Call in assistance from those you trust – start with your accountant, then consult trusted acquaintances who know your business.
- Keep an eye on your business’s focus, the value it brings to your clients and the market as a whole – the reason you are in business in the first place. If the changes you make take the business outside of this, you’ll likely be adding to your woes later. The changes you make should be in-line with your core business values.
- Keep talking to your stakeholders and business partners. Make sure those who ‘need to know are in the know’. This is a basic foundation of trust, and you really don’t want to undermine that, otherwise you may start losing key support.
2. What impact is the crisis likely to have?
Dig out your cash flow forecast planning sheets. These were the ones you created when analysing your business’s operating cash flow needs and the ‘what-if’ scenarios that went with it. Look at the following:
- Which areas of your business have been impacted and which will have the greatest impact?
- What’s your current cash position?
- What is the minimum amount of cash required to keep the company operating for a defined period and satisfying your essential client needs.
- What costs are essential and which are not? Dig deep on this and prepare to be ruthless if need be.
- Are your clients also impacted by the crisis, or is the crisis just affecting your business?
- What debts are likely to fall due over what periods?
- How quickly can you reduce your accounts receivables?
- Revise your cash flow forecasts and set out new projections for the next 6 to 12 months, allowing for the variables above that you think are realistic, and perhaps a few you think may never happen. The point is to really stress test your business scenarios.
3. Emergency short term action
Once a crisis is apparent and the facts present themselves, it’s important take action quickly to preserve your cash reserves. Consider the following short term actions:
- All non-essential spending to be frozen.
- Essential purchases to be approved first.
- Impose spend limits on essential purchases.
- Freeze salaries.
- Freeze hiring.
- Review temporary staff positions.
- Look to improve working capital: Approach creditors for short-term revisions in payment terms. Reduce your accounts receivables.
- Consider invoice financing; this is a way to finance your business short-term based on your legitimate receivables.
- Look for other sources of financing, such as government loans or grants, private financing options, bank loans.
During a crisis, it’s essential to have up-to-the minute information about the financial state of your business. Central to this is accurate and up to the minute set of management accounting reports. These allow you to snap-shot the current financial state of affairs, from the state of your receivables, current liabilities, cash in the bank, P&L and balance sheet. The systems you use will dictate how readily this information is to you. Those businesses already using cloud accounting software will have this information to hand, because of the flexibility tools like Xero Accounting Software provide. If you’re not using management reports in this way, here’s an article on why management accounts are critical to the operation of your business.
4. Strategic, longer term actions
It’s important to regularly review the situation your business finds itself in and, if you can, plan for a post crisis future. Although not welcome, crises can be beneficial in some ways. A time of great change can shake up a business and make it realise what it has been missing out on. For instance, complacency in business is another major business killer. Complacency comes in many forms, but usually occurs when a company is enjoying profitability and success for a long period of time. However, many things can upset the utopian world, not least:
- Taking your eye off the competitive situation and losing market share.
- Not responding to changes in the market; becoming irrelevant.
- Being unaware of changes in consumer attitude and buying trends; being replaced.
- Not taking advantage of new technologies and processes.
- Internal systems that become inefficient and expensive to run.
- Staff becoming lazy in their duties.
- A feeling of entitlement among key staff members.
- Poor crisis cash flow planning, indeed, poor planning.
- Lack of realistic growth plans.
- When responding to a crisis, many of these issues will surface and need to be resolved.
There are other essential issues you should be look at when planning a recovery too.
Account planning
Consider the origin of your cash; your key clients. Crises that extend beyond your business may naturally be affecting your clients and your suppliers. They may approach you either for quick payment or delayed payment terms, just as you may ask. Relationships in business are another source of life and need to be protected.
As part of your crisis planning, review your clients and suppliers and their fundamental importance to your business:
- Which ones could be sidelined temporarily?
- Which should you look to accommodate as much as you can?
- Can your cash flow support extended credit terms for key clients that have also been affected.
- Consider reduced payments or temporarily suspend contracts.
- Can you use this opportunity to negotiate better terms with suppliers, or even clients?
Operational efficiency
Crises may reveal underlying problems in your business processes, typically things you have taken for granted in the past that may now be a burden. One example may be your IT systems and software licensing. If you have internal staff managing this, maybe it’s time to consider a more effective outsource solution. Equally, if you do outsource, maybe your contractor has become complacent too and now is a time to make a competitive comparison and ask for more favourable terms.
Software licenses: These have a habit of auto renewing. Make sure you are still using the software and that it’s still needed.
Review your staff structure: Are you using your headcount efficiency?
Is everyone really pulling their weight? Could tasks be combined, and staff levels reduced?
Unused inventory and inventory levels: Are you sitting on inventory that is either sold or represents unused material? Can this be returned or recycled? How much does it cost to store these items and are cheaper options available? Could you move to a more efficient ‘just-in-time’ practice, thus reducing exposure.
Office space: Going forward, do you really need your current office space. Changes in working practices may mean that more people can work from home and share office space if needed. Review your current leasing arrangements and perhaps plan for smaller offices in the future, investing instead in technology and processes that enable a more geographically dispersed staff base.
Check out some of our articles explaining the benefits of Xero:
Accounting practices: Review your accounting and financial management practices. Some companies have in-house accounting or bookkeeping staff. With improvements in technology, cost efficiencies can be gained. Also, it may be better to outsource your accounting function. It’s a popular choice these days, especially as cloud software such as Xero allows delegated people in a company direct access to up to the minute operational financial data. Regular management reports can be run, up to the minute cash flow reports can be created and receivables information is at your fingertips. The best thing is, with this technology, you can have access to essential management information no matter where you are, through your mobile devices.
Closing thoughts
As we have seen, cashflow management and planning is the gateway to understanding your business’s ability to weather a crisis and it’s also a testimony to the quality of your business management too.
Consider also that, crises don’t just represent a clear and present danger. Provided a company is essentially sound and financially viable, a crisis can also represent an opportunity. Weathering a crisis is an opportunity to review your company’s operations and to look for opportunities where perhaps other competitors are not able to recover so well.
Crises are times when a company is stress tested by natural events. As such it can be an opportunity to make more drastic changes to your company’s operation – justifiably so.
The message is then, don’t panic, react calmly. Take a balanced look at what steps you have to take to weather the storm. But, also use this as an opportunity to emerge a stronger and more competitive company.
The business world is more data-driven than ever before, to the point that even the smallest businesses now need the flexibility and accessibility to critical business data at their fingertips, rather than just when they review things with their accounting or bookkeeping staff.
Cloud accounting tools like Xero can help. No matter, where you are or what device you have, you have access to essential financial management information 24/7.
Furthermore, data-driven accountants like TaxAgility can help you get a better grasp of your company’s day-to-day financial management too, particularly in how to prepare and respond to business crises.
So contact us and find out how we can help in a proactive way.
Domestic VAT reverse change for building and construction services
Traditionally, the value-added tax or VAT is a tax based on a percentage of the sale price; and is applied at each stage in the production and distribution chain. However, for the construction industry, that's all changed.
From 1 March 2021, the new VAT domestic reverse charge system for building and construction services will take effect. As the name implies, it only affects jobs that building tradespeople carry out for their clients in the construction industry.
This new system aims to reduce the missing trader fraud common in the construction industry, whereby a supplier or subcontractor would invoice and charge VAT to another builder, before going missing or going into liquidation. With this reverse charge, the VAT is moved down the supply chain, making the main contractor responsible for the VAT and pay it directly to HMRC.
To aid the process, the government has published a flow chart which lists key questions that can help you determine whether a reserve charge should be applied or not if you are supplying services customers. As such your customer must have the following attributes:
- Does the supply fall within the scope of Construction Industry Scheme (CIS)?
- Is the supply standard-rated or reduced-rated?
- Is your customer VAT-registered?
- Is your customer registered for CIS?
- You’re not an employment business supplying staff or workers
- Your customer has confirmed that they are not an end user or an intermediary supplier?
If the answer is ‘yes’ all of these questions, then the domestic reverse charge applies, meaning when you issue an invoice to your main contractor, you don’t include VAT on your invoice. Instead, your invoice should state “Reserve charge: Customer to pay VAT to HMRC", along with the VAT rate. This is to make it clear that the reserve charge system has been applied, and the main contractor knows what rate to declare on their return later.
If the answer is ‘no’ to any of the first four questions, then normal VAT rules apply.
Further guidance provided, explains some of the differences between ‘end users’ and ‘intermediary suppliers’.
What is the difference between an end user and an intermediary supplier?
End users are the actual consumers or final customers of a service. The reverse charge does not apply to end users.
An intermediary supplier is a CIS and VAT registered business connected or linked in some way with an end user. This connection could be through the holding of relevant interests in the land or buildings with the construction work is to take place. Landlords and tenants are an example, as are constructions services carried out within a group of companies.
Further helpful definitions
To help define the circumstances and applicable scenarios further the government provides the following additional guidelines:
When you must use the reverse charge
- Constructing, altering, repairing, extending, demolishing or dismantling buildings or structures including offshore installation services;
- Constructing, altering, repairing, extending, demolishing of any works forming, or planned to form, part of the land, i.e. walls, roadworks, power lines, electronic communications equipment, aircraft runways, railways, inland waterways, and more;
- Installing heating, lighting, air-conditioning, ventilation, power supply, drainage, sanitation, water supply or fire protection systems in any building or structure;
- Internal cleaning of buildings and structures, so far as carried out in the course of their construction, alteration, repair, extension or restoration;
- Painting or decorating the inside or the external surfaces of any building or structure; and
- Services which form an integral part of, or are part of the preparation or completion of the services i.e. site clearance, earth-moving, excavation, tunnelling and boring, laying of foundations, erection of scaffolding, site restoration, landscaping and the provision of roadways and other access works.
When you must not use the reverse charge
Do not use the charge for the following services, when supplied on their own:
- Drilling for, or extracting, oil or natural gas;
- Extracting minerals and tunnelling, boring, or construction of underground works, for this purpose;
- Manufacturing building or engineering components or equipment, materials, plant or machinery, or delivering any of these to site;
- Manufacturing components for heating, lighting, air-conditioning, ventilation, power supply, drainage, sanitation, water supply or fire protection systems, or delivering any of these to site;
- The professional work of architects or surveyors, or of building, engineering, interior or exterior decoration and landscape consultants;
- Making, installing and repairing art works such as sculptures, murals and other items that are purely artistic signwriting and erecting, installing and repairing signboards and advertisements;
- Installing seating, blinds and shutters; and
- Installing security systems, including burglar alarms, closed circuit television and public address systems.
Some basic examples of how this works in practice
Example 1: a transaction under reserve charge
You are a subcontractor who is VAT-registered and you charge 20% VAT normally. You carry out painting and decorating work in an office block for the main contractor AB Construction Ltd. Upon completion, you invoice AB for £2,000 on paint and other materials, and £4,000 for labour. You charge £6,000 in total but no VAT. Your invoice will mention the VAT rate (20%) and the phrase ‘Reserve change: Customer to pay VAT to HMRC’.
On your VAT Return:
- VAT on sales – suppliers must not enter output tax on sales under reverse charge. The supplier only need to enter the net value.
- VAT on purchases (goods) – if you buy services subject to reverse charge, you must enter the VAT charges as output tax on your VAT return. Make sure you do not enter the net value of the purchase as a net sale.
- If the services provided (expertise/labour )are subject to reverse charge from the subcontractor, the VAT must be accounted for in your VAT return and VAT will be recovered simultaneously on the same VAT return.
Example 2: a transaction not under reverse charge
You are a subcontractor who is VAT-registered and you charge 20% VAT normally. You carry out painting and decorating work in an office block for the owner, who confirms that he is the end-user. Upon completion, you invoice the owner £6,000 for the materials and labour, plus £1,200 for VAT.
This is reported normally in your VAT return.
Important note on the cash accounting and VAT flat rate schemes
An important point to note here is that the cash accounting scheme cannot be used for supply of services that are subject to the reverse charge. The same is true for the flat rate scheme (FRS). Users of these schemes will need to consider whether it is still beneficial to their businesses to use these schemes.
This will impact likely your cash flow, so be aware
Under the old scheme, a business would charge their fee plus VAT. If the customer was a prompt payer, the charging business would have a 20% cash flow advantage from the VAT, potentially for up to 3 months. Under the new scheme, the business won’t charge VAT and therefore won’t benefit from the cash flow advantage.
If you aren’t sure, talk to TaxAgility
Prepare yourself by making sure that your accounting systems and software can deal with the reserve charge, and take time to review your contracts with other builders and suppliers.
At TaxAgility, we are also here to provide professional guidance on this issue. You can speak to our VAT specialist.