Posted on 5 September, 2018  |  4 mins

Keith Tully │ 9 Spokes cash flow testCash flow affects all businesses—particularly SMEs. It can cause uncertainty and confusion. Which is why Keith Tully, partner at Real Business Rescue, suggests running a cash flow test, plus a balance sheet test to see the bigger picture. Here’s how...

Cash flow is the beating heart of any successful businesses. It is what enables bills to be paid on time, while also providing ready cash in case of emergencies, or to fund a growth or expansion project.

Once a company’s cash flow dries up, problems can quickly follow.

Without the money to pay suppliers, your stock levels can quickly diminish. An inability to pay your staff on time could see you lose the employees who are key to the success of your business. So, it is absolutely vital that you retain a strong grip on your business’s cash flow and know exactly where you stand. A great way of doing this is to conduct what is known as a cash flow test.

By conducting cash flow tests at regular intervals, you put yourself in the best possible position to spot impending trouble and stem any issues before they have a chance to start causing damage to your business.

What is a cash flow test?

A cash flow test is one of several insolvency tests which can be undertaken on a company. It’s a great way of seeing your business’s financial position, particularly how it handles its day-to-day transactions.

The test looks at your company’s incomings and outgoings to check whether its liabilities can be met as and when they fall due. An inability to keep up with its liabilities is a huge red flag that your company is heading towards, or is already, insolvent.

What if the results of the test are bad?

If the outcome of the cash flow test is not positive, don’t panic. All is not lost; you just need to put a plan in place to get things back on track. Poor cash flow does not necessarily mean your business is bad; it just means the management of your finances needs to be improved.

The best place to start with this is by getting to the root of the issue. Is your cash flow suffering because your creditors are not paying you on time? Are you not making a large enough profit on the sales you are making? Or are you simply not generating sufficient sales in the first place? Knowing the reason behind your poor cash flow gives you the best starting point for improving matters.

If your problems are internal, such as poor sales or slim margins, you should investigate your sales strategy. Consider whether your marketing efforts are working, or whether you are in the position to increase the retail price of your product or service. You should take an objective view of your business, which means taking your emotional connection out of it. If you are unable to increase your profits or lower your outgoings, you need to decide whether, in pure business terms, it is viable going forwards.

If your problems stem from issues external from the business, perhaps because of late payers or from previous suffering bad debt, for example, you may need to re-evaluate your processes for issuing invoices and collecting payment. You may also like to consider whether invoice financing could help your cash flow flow more freely.

Does this differ from a balance sheet test?

With this in mind, you should be careful about placing too much emphasis on the results of the cash flow test alone. As previously stated, a cash flow test is one of a number of insolvency tests, and it is always prudent to undertake several if you suspect your business could be heading towards danger. Doing just one of these tests won’t give you the complete picture you need to assess your company’s finances; by looking at two in conjunction, you are able to get a more accurate picture of your businesses finances.

A particularly useful insolvency test to undertake alongside a review of your cash flow is the balance sheet test. While a cash flow test looks at how your company is handling its finances on a day-to-day basis, a balance sheet test considers the bigger picture. It looks at a company’s liabilities in comparison to its assets.

It’s common for a business to be asset-rich but cash-poor; meaning even though it may have a significant amount of value tied up in property, vehicles and machinery (for example), it may still have problems meeting its day-to-day running costs. So while a balance sheet test may show your company as being in a solvent position overall, a cash flow test could highlight potential issues when it comes to accessing the money needed to pay its day-to-day costs.

Likewise, a company operating with healthy cash flow may technically be insolvent should the company have run up considerable liabilities which will eventually need to be cleared. While the company may be able to comfortably service their liabilities at the current time, these debts and other financial commitments could become a burden to the business further down the line. 

What are the next steps?

The important thing to remember is that regardless of the outcome of these tests, there are options out there which can help get your company back on track. Conducting regular checks on your company’s financial situation helps you take action at the first signs of trouble, increasing the likelihood of you successfully negotiating your current problems.

Written by Keith Tully, partner at Real Business Rescue. Keith has more than 25 years’ experience advising business owners on a range of operational issues, including cash flow, finance, tax and insolvency.

Cash flow test │ 9 Spokes