Plain English guide to cashflow
Positive cashflow is the beating heart of your business. Dive into our Plain English guide to cashflow and find out how to get in complete control of your cash position.
Starting a business can be daunting between sales, marketing, and day-to-day financing, plus there is the big question of which business structure to use.
The three most common types – a company, a partnership, or a sole trader – have very different cost and administrative burdens, as well as different implications when it comes to legal status and liability.
Find out more about the pros and cons of each below.
Going it alone as a sole trader
A sole trader structure is where one person owns and runs a business.
The benefits of operating as a sole trader lie in its simplicity. It’s extremely easy to set up, and tax-wise, all a sole trader needs to do is report their profits or losses in their personal tax return. What’s more, being a sole trader doesn’t prevent you from having employees if you want to grow your business.
However, a sole trader structure can be risky. As sole traders have ‘unlimited liability’, if the business runs into any financial or legal trouble, then you are personally liable for the fallout (this makes a good insurance policy all but a necessity for this kind of structure). It can also be difficult to attract outside investment as a sole trader, as you have no shares or equity to offer potential investors.
Working within a partnership
Put simply, a partnership arises when two or more people go into business together.
Partnerships can be a great way to pool knowledge and resources, making it cheaper and easier to start and maintain a business. From an administration perspective, partnerships are also extremely easy to set up, though a partnership agreement (and a written confirmation of the partners’ profit-sharing arrangements) should still be documented, as this will help avoid any potential disputes in future.
Partnerships are also relatively stress-free from a tax perspective. This is because (unlike a company) partnership profits aren’t paid at the partnership level. Instead, partners report their share of partnership profits in their personal tax returns, with those profits subject to tax at the partner’s marginal tax rate.
However, there are downsides to a partnership. For one, partnerships are more work than a sole trader structure, and they don’t benefit from the legal protection that a company offers.This means if the partnership ends up in debt, the partners are typically liable to repay those debts jointly and severally. There are ways to reduce this risk (for example, by forming a limited partnership) but this is best navigated by taking legal and professional advice.
Operating as a company
A company is a legal entity, separate and distinct from its owners (known as shareholders). A company may have one shareholder, or many.
One of the big draws of a company is limited liability, with a shareholder’s financial liability typically limited to the amount they’ve invested in the business. Companies are also an attractive structure to consider if you ever want to bring on external investors, or if you think you may ultimately sell your business down the line.
However, companies have their downsides. For one, they cost more to run compared to a simple sole trader structure. In addition to initial set-up costs, companies must also comply with various legal and regulatory requirements, including regular accounts preparation and tax return filings.
In addition, because of the legal separation between a company and its owner(s), remember that any funds in a company’s bank account belong to the companWhy is cashflow so central to good financial management? Here's our plain english guide.
What is cashflow?
Cashflow refers to the movement of money into and out of your business over a specific period.
In the most basic terms, cashflow is the process of cash moving out of the business (cash outflows), and cash coming into the business (cash inflows). The ideal scenario is to be in a ‘positive cashflow position’. This means that your inflows outweigh your outflows – i.e. that more cash is coming into the business than is going out.
When you’re cashflow positive, the main benefit is that you have the liquid cash available to fund your daily operations and debt payments etc.
On the flip side, if you’re in a negative cashflow position, this can be a red flag that the business is facing some financial challenges – and that some serious cost-cutting and/or revenue generation is needed.
How does cashflow affect your business?
Not having enough liquid cash is one of the biggest reasons for companies failing. So it’s absolutely vital that you keep on top of your company’s cashflow position.
Six key cashflow areas to focus on include:
Monitoring your cash inflows and outflows – this means regularly tracking your cash inflows from sales, loans and investments, as well as managing your cash outflows from expenses, purchases and debt repayments.
Managing your account receivables and payables – efficiently managing your customer receipts and supplier payments helps smooth out your inflows and outflows – and delivers stable cashflow that’s easier to predict and manage.
Getting proactive with your budgeting and forecasting – creating realistic cashflow budgets and forecasts helps you predict your future cash position. By anticipating your future cash needs, you can actively plan for potential shortfalls or surpluses. This should consider both fixed and variable overheads.
Investing in your cash reserves – with emergency cash reserves in the bank, you know you have the funds to handle unforeseen cashflow issues or sustain your operations during lean periods. This makes your whole cashflow position more stable.
Being in control of your stock inventory – having excess stock in your warehouse ties up cash. So, it’s a good idea to optimise your inventory levels and to only manufacture/order the items you need on a day-to-day basis.
Tax obligations – can trip up a lot of small businesses. Setting aside a percentage of every sale into a separate account avoids the nasty surprise when a payment date arrives.
How can our firm help you with cashflow management?
Positive cashflow is the beating heart of your business. Working with a good adviser helps you keep that cashflow healthy, stable and driving your key goals as a company.
We’ll help you keep accurate records, track your inflows and outflows and deliver the best possible cashflow position for the business.
Get in touch to chat about improving your cashflow.