Cashflow Improvement part 3
September 27, 2013
In the last series of three blogs we will look at some useful tips in order to help you improve your firms’ cash flow.
The SRA Handbook is made up of 10 mandatory principles which all managers and employees play a part in fulfilling. Principle 8 states:
‘You must run your business or carry out your role in the business effectively and in accordance with proper governance and sound financial and risk management principles.’
Two of the indicative behaviours relevant to this are as follows:
IB 7.2 controlling budgets, expenditure and cash flow;
IB 7.3 identifying and monitoring financial, operational and business continuity risks including complaints, credit risks and exposure, claims under legislation relating to matters such as data protection, IT failures and abuses, and damage to offices;
As well as this, the SRA have published guidance on what they feel constitutes good and poor indicative behaviours in relation to financial stability. This blog will look at some of these poor behaviours and how your firm could implement changes to improve its cash flow and keep control of its finances:
1) Partners’ drawings
Minimising the amount Partners draw from the business will inevitably improve cash flow. Have you actually considered how much the business can afford to pay out in drawings? Do Partners drawings exceed the profits generated from the business? As the business owners, the Partners are expected to part fund working capital through their own undrawn profits. Certainly, the Banks are carefully reviewing Partner capital levels compared to their lending levels. Irresponsible payments made to Partners are an indicator to the SRA that your firm may be at risk of financial difficulty. Consider:
– Changing the firms’ drawings structure. Does the ‘drawings plan’ correspond with ‘profit’ targets or ‘cash collected’ targets? Remember, the business can be highly profitable, with a negative cash flow so structuring the Partners drawings in line with the cash you collect is a sure fire way to keep control of the cash flow.
– Reducing drawings to meet the Partners specific financial needs. If the business is struggling to meet on-going financial liabilities, should you reduce the Partners drawings. Are you risking insolvency by paying Partners before your other creditors?
2) Short term borrowings to fund partners’ tax bills
The SRA have indicated that evidence of potential financial difficulty is the need to raise finance to meet personal tax liabilities. Partners’ tax liabilities should be included when setting up a ‘drawings plan’. Drawings should be determined as follows:
– If it is decided that the Partners meet their own tax payments, drawings can be structured without taking these payments into account. No additional draw should be allowed to cover personal tax liabilities.
– If it is decided the firm should fund these tax payments, a provision should be made against the Partners drawings and cash set aside in a separate bank account to meet these liabilities as they fall due. If the firm adopt a ‘cash collected’ drawings plan then a tax provision should be deducted from this before drawings are paid to the Partners.
It is important that drawings are controlled responsibly and tax payments are taken into account. Short term borrowings can be costly and will inevitably impact on cash flow in the future. Also remember that lenders require sight of the financial accounts before they agree to provide finance and high borrowings compared to low profits could lead to a failed lending application.
3) VAT receipts used as ‘cash received’
In my last blog I discussed how you can use your firms VAT scheme to improve cash flow. The SRA have indicated that the use of VAT receipts as ‘cash received’ is also evidence of potential financial difficulty. This is particularly relevant when borrowing is required to fund VAT liabilities payable to HMRC, so a provision should be made for this in your cash flow regardless of the scheme you use. A separate bank account could again be used to transfer a proportion of the VAT on fees received to help meet liabilities as they fall due.
It is highly recommended that your firm prepares a monthly cash flow statement taking these three factors into consideration. It is also worth noting that this list is not exhaustive and your cash flow statement should be tailored to meet the requirements of your firm. Your cash flow statement should be reviewed regularly alongside key management information to ensure cash is not being spent in unprofitable areas. A good behaviour would be to provide all Partners of your firm with regular financial updates and include them all in decision making processes, not just senior management.
For more information and advice on any of the matters raised in this blog, please contact us on 01772 821021.