Businesses fail when they run out of cash. Now this is normally associated with suffering losses, but there can be other causes as well. Profitable businesses which have excess investment in illiquid assets or which are achieving excess growth can also end up going under due to cash flow problems, factors that may be particularly important as businesses attempt to regrow after the current recession. This article looks at how and why businesses get into real cash flow difficulties and what to do about it.

Where do cash flow difficulties come from?

Cash flow difficulties are often seen as a result of losses as a business falls into decline.

A business which is underperforming generates smaller profits to reinvest in new products or efficient operations or plant and over time it starts to slip further and further behind as it loses its competitive edge. When it does so its market reputation and share will further fall in a slow but inexorable cycle, until losses start to eat further into its cash. Distressed businesses begin to stretch their creditors as part of managing its cash, something its bank's systems will pick up on and soon leads them to tighten their criteria for providing funding. Crown and supplier payments start to fall further and further behind as management tries to make ends meet and as staff realise the problems, morale and the quality of work sinks driving the business further down the slope towards a real cash crisis.

However successful and profitable businesses can often also get into real cash flow difficulties from too much growth. 'Overtrading', where a business grows too fast for its available finance, is a relatively common cause of failure in boom times and is a particular problem as companies try to expand again when an economy comes out of recession.

But even steady and profitable businesses can find themselves facing a real cash flow crisis if they fail to manage their working capital and end up with too much cash tied up in illiquid assets.

Managing a real cash flow crisis

In a turnaround situation cash equals time and so in a crisis it is vital to see how much cash/time you have, and then what can be done to increase it.

The key to understanding your position is a cash flow forecast. In these circumstances you will need to concentrate on the short term. It is usual to prepare a forecast on a weekly basis for the next 13 weeks, but in extreme cases you may need to prepare one on a daily basis, covering only the next few weeks.

The cash flow forecast will be a vital document, for:

- actively managing the cash to ensure survival

- obtaining proper advice as to whether to continue to trade (to protect your personal position) and

- obtaining and maintaining bank support.

You will have to make reasonable assumptions so there will always be an element of judgement and guesswork in any forecast. However, cash flow forecasting should be a relatively straightforward exercise in planning the expected real cash movements into (cash sales, debtor payments, new investment received) and out of (payments to suppliers, rent, wages, PAYE, loan instalments, VAT payments and so on) the business.

For a weekly forecast, all you are looking to calculate is therefore how much cash you are going to get in that week, less how much cash you are going to pay out that week, which gives you a net movement ('flow') of cash into or out of the company. The total of the balance brought forwrad at the start of the week, plus or minus the movement in the week gives the balance you expect to have at the end of the week.

The secret of successful cash flow forecasting is to take a simple and methodical approach, be clear about where you are starting from (is it your cash book balance or per bank statement?), be realistic and prudent in your estimates of values and timings, particularly of cash coming in, leave a contingency to cover surprises, make sure it adds up properly, and always have a note of the key assumptions you are using so your bank or whoever else needs to see it can follow what you have done.

Control the cash you have

Once you have prepared your cash flow forecast, use it to help control this scarcest of resources and ensure it is used as efficiently as possible:

- Centralise control of all cash receipts, payments and forecasting. Then you can prioritise and schedule payments to make best use of the available cash.

- Increase the level of authority required for purchasing or payments and cancel or restrict the use of credit/charge cards so that cash is not wasted or committed outside the central cash management process.

- Continue to roll the forecast forward regularly. Each time you do so, review the actual performance against what was forecast to see how accurate you were, identify variances that need to be investigated, and gain feedback with which to improve accuracy going forwards.

By preparing a cash flow forecast you may also be able to identify where the cash is leaking out. Is it particular branches, sites or parts of the business? You should use the cash flow document as an active management tool, both to target these areas for specific reviews and remedial action, and to help you think more widely about what other sources of cash can be identified, or outflows modified to help manage the position.

If money tied up in high stock or debtor levels are part of the cause of your cash problems consider bringing in a Lean Cashflow process expert to help free this up.

Of course the information contained in an article like this can never be a full statement of the legal position as the relevant laws are complex and liable to change. This article can only therefore be a general guide as to the issues involved and you should always seek appropriate professional advice on your own particular circumstances before taking any action.