Keeping tight control of your working capital can speed up the flow of cash into your business. Faster cash flow reduces the requirement for borrowed funds.

In this chapter, three things that really matter:

• ˜ Negotiating funding from your creditors
• ˜ Gaining funds more quickly from your debtors
• ˜ Reducing stock levels to finance cash flow

When you establish your business you need to give a great deal of thought to your working capital requirement. Working capital is the amount you have invested in your business in terms of stock and debtors and the amount that others have invested on a short-term basis, i.e. your creditors.

You need to be aware of the implications upon cash flow if your debtors fail to pay on time, or if you hold too much stock. Both of these tie up more cash than necessary, which could impact upon your ability to pay your debtors. In some cases this is a primary reason for business failure.

It is, therefore, important that you obtain the right balance from the outset. Remember, you can sell all of your stock at a paper profit but until you receive the cash it is not an actual profit. And until you can actually pay for the stock you have sold you are unlikely to be able to buy any more.

Is this you?

I won’t be able to obtain credit, I haven’t got any track record yet to enable a reference to be obtained. • I don’t intend to allow any of my potential customers any credit, I can’t afford to. • What difference does it make how much stock I hold or when I place any new orders? The supplier still delivers within 48 hours.

Negotiating funding from your creditors

Many start-up businesses do not consider that they will be able to gain any credit from their suppliers. This is not always the case. Trade credit, as it is known, can be available but it will depend on the circumstances. If, for example, you are starting your business at an early age having just left school or university then yes, you may have problems obtaining credit.

If, on the other hand, you have been employed for many years in the same industry that you are now starting your own business in, you may find that obtaining trade credit is not difficult. You have an established track record in the industry and probably already know the suppliers with whom you will be dealing.

• ˜ The essential point is that you must research what is available. In other words, before you even start your business you must establish how much credit you can obtain and how long you will be given to pay. You cannot, for example, draw up any meaningful cash flow forecasts unless you assume from the outset that no credit will be available.

It can also take time to negotiate trade credit. In most cases, some form of reference will be required, probably from your bank. All banks have different philosophies when it comes to giving a reference on their customers and you will need to check the exact position with your own bank.

Keep to the terms of trade

Having gained agreement to a credit account it is extremely important that you do not abuse that facility. It can be withdrawn just as easily as it was granted and this could place severe pressure on cash flow. Always adhere to the agreed terms of the credit and make payment promptly when it is required.

• ˜ Failure to pay on time could also render you liable to penalties.

Legislation was introduced in 1998 to allow, under certain circumstances, for interest to be charged on outstanding invoices at the rate of 8% above Bank of England base rate. This could be a substantial amount and is therefore something that you should avoid at all cost. If, of course, your creditors start to charge you on this basis it is also likely that they will have already withdrawn your credit facility.

Using personal credit cards

Another aspect of gaining credit that most business owners ignore is the fact that personal credit cards can also, at least initially, be used for this purpose. Most credit cards allow for up to 56 days, interest-free credit provided the outstanding balance is settled in full. There is absolutely nothing to stop you using this facility for your business, although you will need to keep a careful track of the relevant records.

Trade credit is not something that is only available to established businesses. In these times of intense competition, suppliers need to be flexible in how they make their sales.*

Gaining funds more quickly from your debtors

As you will have gathered from the previous section, whilst it may not be your initial intention to provide credit to your own customers, you may have little choice. It is important, therefore, that from the outset you realise the implications upon the funding for your business. You will be providing a loan to your customers to purchase your goods or services, such a loan to be paid at some defined time in the future.

As a consequence, it is vital that you set out clearly defined terms of trade. You also need to be sure that when you grant credit to someone you know that they will have the means to pay you. You should never be afraid of refusing credit if you are in any doubt. You may lose the sale but it is better to lose the profit element on this sale than the whole amount of the sale itself by way of bad debt.*

When you start your business it is unlikely that you will be able to take advantage of the two main ways in which you can gain funding based on your outstanding debtors. These are:

• ˜ factoring
• ˜ invoice discounting.

Under normal circumstances these are only available to businesses who have a turnover exceeding £250,000 and £1 million per annum respectively. If, however, you do envisage such a turnover it is important that you understand the differences between the two.

Factoring your debts means that you can obtain an immediate advance against your outstanding debtors. This usually equates to a maximum of 80% of approved invoices. In this case/approved’ means that the customers have been approved as debtors by the factoring company. The factor also assumes control of your sales ledger, issuing statements and reminders on a set basis.

The advantages of factoring are:

• ˜ It improves cash flow with a faster collection of trade debts.
• ˜ It removes the need to chase unpaid invoices.
• ˜ It is a simple process and insurance against bad debts may be available.

The disadvantages of factoring are:

• ˜ Your customers know that you are using the factor – in some cases this does have a stigma attached to it.
• ˜ It can prove costly in overall terms.
• ˜ Once you have taken out a factoring arrangement it can be difficult to extricate yourself from it.

Invoice discounting operates on broadly the same principles as factoring but with two main differences:

• ˜ Control of the sales ledger is retained by you and you will therefore need to control the debtors and chase for late payment yourself.
• ˜ Because you retain control, the existence of the invoice discounting arrangement is not evident to your customers – it is entirely confidential.

Because the principles are broadly the same in each case, both factoring and invoice discounting share the same advantages and disadvantages. The only difference is the perception of your customers when, rather than dealing with you concerning their invoices, they deal with the factor.

Reducing stock levels to finance cash flow

You may consider it strange that in a book about raising finance there is a section on stock included. Stock is, however, a very important consideration when you are considering finance. Holding too little stock could mean that you lose sales, but holding too much stock means that you have less cash available for other purposes. This means that you have to raise unnecessary finance which then costs you more money in interest.

• ˜ Controlling your stock levels is, therefore, an important part of your financing.

When you establish your business, you may consider that initially you are going to require say £10,000 of stock. In itself, that will not affect your financing decisions. Provided your estimate is correct, you will actually require that amount of stock. The important question comes when you sell some of that stock and then need to replace it. How much more stock do you need and when should you order it?

Consider discounts carefully

Some businesses make the mistake of ordering in bulk in order to obtain discounts. This means that at any one time they probably have more stock than they can sell within a reasonable time. The effect of the discount is subsequently eroded because more cash than necessary is being used to finance those stock levels. If you are borrowing money for such purposes, for example, by way of bank overdraft, the interest is probably costing you more than you gain from the discount.

If, on the other hand, you ignore the offer of discounts and only purchase the stock that you can actually sell within a reasonable time, you reduce the cash requirement, and consequently the interest paid on the overdraft. In real terms this would probably mean that you are actually better off in terms of profit.

Say, for example, you sell a certain quantity of goods each day and your supplier can deliver replacement stock every other day. Theoretically, you could reduce your stock levels down to just two days’worth of sales. This would, however, be a somewhat drastic approaches you are then relying on the supplier to deliver on time. If something happens to the delivery which delays your supplies, you could find that you have totally run out of stock.

Realistically, however, by building a contingency level into the stock requirement, you could perhaps manage by holding perhaps seven days’supply. This would mean that on the second day your shelves will be depleted but if the delivery arrives as planned this will be short-lived. If the delivery does not arrive for any reason you still have sufficient stock to trade for a further five days. This technique, referred to as ‘just in time’, was pioneered in Japan and is now used extensively throughout industry.*

Summary points

• * Obtaining trade credit is not impossible for a start-up business – there are likely to be many sources for your supplies, so shop around.
• * Never abuse your credit facilities – always pay your debts on time and you will establish a good track record for your business.
• * Do not forget that you can use personal credit cards to obtain interest-free credit -just make sure you keep accurate records.

• * Keep tight control of your debtors and make sure they pay you when they are supposed to.
• * If you are thinking of factoring or invoice discounting, consider carefully what this will mean – both can be difficult to ever repay and can be expensive.
• * Examine your stock levels on a regular basis – cash tied up in stock cannot be used for other purposes.