The words ‘financial issues within your business’ can sound terrifying. For some people, it conjures up images of fraud, bankruptcy, or something equally as catastrophic. However, and importantly, this doesn’t need to be the case especially not if you’re staying on top of your finances regularly (e.g., carrying out a daily reconciliation or operating with a cautious cash flow).
Early warning signs of a financial issue
There are key early warning signs that highlight when an issue might be arising. The aim is to spot an issue when it’s still only a risk (i.e., could happen but hasn’t happened yet) or if it’s occurred, while it’s still small enough to only require simple intervention. There’s a term that describes this: decline curve.
The ‘decline curve’ of a business
The decline curve is used to assess how serious the difficulties are within a business and you should be aware and act at the earliest opportunity. Within the phases of decline, this is called ‘underperformance’, which is where a cash-generative business loses profitability through decreased sales and/or rising costs.
The next phase is called distress. This is where the business isn’t able to afford any non-essential/non-core expenditure. It might also be the case that the business is having difficulty meeting its commitments to creditors.
The final phase is crisis, where there’s a critical shortage of cash and all cash must be used to meet debts – something we’d like to help you avoid!
Examples of early warning signs
- Consistently declining sales – sales can naturally fluctuate month-on-month and there can be seasonal peaks for several businesses. However, if your year-on-year performance is tracking lower than expected, your sales are falling well below target, or there’s a constant downward trend then there might be an issue.
- Unexpectedly increasing costs – costs can quickly spiral: something that’s a challenge for everyone at the moment. Where there are fixed costs that you can’t reduce or remove, you could easily find yourself in a position where your profitability drops. In some cases, it might be that you’re no longer charging enough to cover costs.
- Growing aged debtors list – if you’re slow with invoicing or you don’t have an effective debt collection process in place, you might find yourself in the position where, on paper, your sales are good but they aren’t translating into cash.
- Worsening cash flow – all of the above will be reflected on your cash flow forecast and this will show when the issues will become problematic for the business. This is why we recommend you have one and update it regularly. It can be a very useful early warning system for you.
How to avoid financial issues (as much as possible)
It’s not possible to entirely avoid financial issues: there are so many things you can’t control. Covid, a prime example of this, is not something any business could have predicted. That aside, there are plenty of steps within your control that you can take.
- A cautious approach to budgeting – we can not state strongly enough just how helpful this is for businesses.
- Understanding your day-to-day costs – paying for unnecessary services is easy to slip into especially when your business is doing well. It’s also something to keep a close on to make sure that you’re not getting carried out and, where needed, you can just nip these in the bud.
- Ensure customers pay on time – this can be helped with technology and Xero is particularly good for this, in our opinion. You can customise invoices to clearly state your payment terms or use specific plugins. The app, is particularly useful for this.
- Monitor financial performance regularly – there are a selection of reports that you should be reviewing regularly.
- Taxes – be informed about which expenses can, and can’t, be claimed through the business to ensure that your tax bill is fair. Also, stay on top of your filing deadlines so that you don’t end up accruing late filing penalties from HMRC as they soon get costly.
What to do if you have a financial issue
It’s straightforward but perhaps not easy. First, accept that you have an issue and don’t be tempted to ignore it and hope it goes away. It’s unlikely that it will and, really, do you want to leave the success of your business up to chance?
Second, seek help if you need it. Some cash flow issues could be managed in-house if you have the flexibility within your budget to reduce costs accordingly or have some cash reserves that you can dip into. However, if you aren’t sure where to even start, please seek help. We’re always here to talk to you. We can help uncover what’s happening in your business, offer support on how to deal with the situation, and offer guidance on how to manage finances going forward.