Setting up and establishing a new business is a time consuming experience. With a good idea, hard work and market demand rewards can be well worth the effort. Yet many business fold within the first 5 years due to financial problems. Cash flow is the biggest culprit and the need to be across the numbers is no exaggeration.
Cash flow
It doesn’t matter how full your order book, if there is a delay between delivery of a product or service and receipt of payment, you may run in to difficulties. A typical example might be if you issue invoices before payment or you’re in the kind of industry where payment is made after work is completed.
For instance, in the construction industry you might spend several weeks on a project, during which you supply materials and labour but only receive payment several weeks later.
Budgeting for the unexpected
You would, of course, budget for the expenditure and anticipated payment date of any project. But that wouldn’t help you when the unexpected happens. A typical example would be if the work takes longer, more labour is required, or the client takes a while to pay.
To begin with, when you price work you always include a contingency, usually around 10% on top of the total. But that alone won’t be enough if you want to stay in business for the long term. You need to get a clear, detailed understanding of how much you spend on every aspect of a job, including labour and materials. That kind of detail comes from closely analysing the numbers. And to do that properly you need to be producing management accounts at regular intervals.
Management Accounts
Management accounts are important for all business types and industries. In the simplest terms they provide an overview of how much money has been spent, received and is owed by the company. By producing management accounts on a regular basis, for instance monthly, you can make informed decisions on product or service price, which products or service work are worth pursuing or any timescale issues.
The information should also help identify areas that may need more investment or in deciding how to improve the profit margin by, for instance, looking at supplier value.
Once you’ve got a handle on the numbers you need to look at the effectiveness of your system of payment and credit control.
Collecting payments
It’s essential to have efficient systems for collecting payments from customers. Setting up an automated payment system can help reduce time spent collecting payments manually. For instance a subscription system or credit card payment in advance for the first hour of a service delivered on site. If clients book services via your website, prepaying by credit card might not involve much of your time and a receipt or invoice could be produced automatically.
You could also simply ask for a credit card payment immediately after a service is completed. Portable credit card equipment using your smart phone provides plenty of opportunities to collect payments on the go and avoids the problem of bad debt.
Bad debt and credit control
Having a clear credit policy will go some way to protect the company from bad debts or unnecessary risks associated with unpaid invoices. If invoices are unavoidable make clear your payment terms and have a simple staged system for credit control.
Credit control should start with a friendly reminder. You don’t want to offend your customers and it could be a genuine mistake.
If you haven’t received payment after a set period of time you would resend the invoice stamped overdue and ask the customer to make payment within a specific period of time. You might also encourage the client to contact you if they have any problems with the work or are experiencing any payment issues.
I would follow this up again using firmer language. Perhaps explaining that if payment isn’t made by a specified period of time or the client hasn’t contacted you regarding payment, you will have no choice but to start legal action to recover the debt. A phone call would also be a good idea at this stage in case the client isn’t receiving emails or post for whatever reason. This usually gets things moving.
If a client refuses to pay because they have reasonable issues you will need to address these first. However, if despite this they refuse to pay, you can persist with your credit control procedures, write the debt off or take legal action. Your decision should be based on the size of the debt and the cost of legal action, the strength of any case the client might have against paying and whether you want to work for this client again in the future.
It’s an unfortunate fact but all businesses that give credit will incur bad debt at some point. If credit can’t be avoided you need to decide how you want to deal with it.
Setting budgets
Management accounts, information from sales and marketing and any business development plans should be taken in to account when setting budgets. The process of budgeting involves deciding how much money should be allocated for each item.
To keep up with changes in the market, it may be necessary to tweak budgets from time to time. As businesses grow, their financial needs may also increase which necessitate redirecting funds or increasing spending on product development. This means that your budget will need to be reviewed regularly.
And finally…
People go in to business for all kinds of reasons. While entrepreneurs may have certain characteristics in common, they come in many shapes and sizes. If you’re an outgoing, active person with endless ideas the thought of working on the accounts maybe doesn’t fill you with excitement. However, keeping on top of your finances when you’re a small business owner is crucial. Particularly if you want to succeed beyond the dreaded 5 year milestone.
If numbers and accounts are not your forte, employ the services of someone who can crunch the numbers for you. You can’t outsource the need to understand and study the accounts. That’s something you will need to do yourself if you want to be in a position to manage and control your business. Like anything, the more you do it the easier it becomes and the greater the chance your business will have to succeed.