In this month’s article on cash flow management for entrepreneurs and small business owners, we’re going to look at how maintaining a positive cash flow can help your business avoid insolvency, and what you can do to ease any financial difficulty your business may fall into.
This is the sixth part in our ongoing series on managing your cash flow, you can read the previous articles here:
- Part One: Cash Flow Basics
- Part Two: Failure to Plan is Planning to Fail
- Part Three: Those Who Shout Loudest Get Paid First
- Part Four: Must Have or Lust Have
- Part Five: Working Capital – Make it Work for You
Part Six: Shelter Your Assets
Maintaining a positive cash flow isn’t just best practice, it’s essential if you’re to protect your business from insolvency.
Insolvency refers to the state of financial difficulty where an individual or company is unable to pay their debts on time.
Insolvency
There are two kinds of insolvency that can affect businesses:
- balance-sheet insolvency – you have enough cash to pay your next bill, but you wouldn’t be able to pay your creditors if they all called in their debts at the same time; even after liquidation
- cash-flow insolvency – you have assets to the value of what you owe, but they’re not liquid and so cannot be used to pay your creditors
There’s a simple test to check for cash flow insolvency: if you’re unable to pay your bills as they fall due, or in the “reasonably near future”, then you can consider yourself cash flow insolvent and could choose to wind up your company under the terms of the Insolvency Act 1986.
The definition of “reasonably near future” can vary depending on the industry, for example, the construction industry is known to endure long payment terms, so you’ll need to consider this when performing the cash flow insolvency test.
Company Status
Whether your business is a limited company or a limited liability partnership can make a huge difference to the financial impact your business debt has on you as the business owner.
The liability of limited company shareholders or guarantors is limited to the amount paid or unpaid on their shares, or the amount of their guarantees, whereas the liability of LLP members is limited to the amount each member guarantees to pay, if the business runs into financial difficulty or is wound up.
You could also consider adopting a group structure, or even placing assets of value in a company pension scheme with little to no risk, to limit your financial liability.
Review Your Position
Review your bank security and personal guarantees and ensure you’re meeting your covenants. It’s in your best interest to meet any and all covenants set by your existing lenders so as to protect the relationship, maintain and improve your credit rating, and avoid situations where your lenders doubt your ability to pay and call in the debt, causing you to sell an asset or turn to less reputable, short-term lenders.
It goes without saying, pay day lenders, loan sharks and anyone offering eye-watering interest rates or painful repercussions if you fail to pay on time should be avoided at all costs.
Rather than focusing on liquidation and closing of insolvent entities, modern insolvency legislation and business debt restructuring practices now prioritise business turnaround, or business recovery, by remodelling the business’s financial and organisational structure. The aim of this is for the business to continue operating instead of being forced to close down.
The next post in our cash flow management series, You’ve Got to Innovate to Accumulate, will shine a spotlight on the investments that could help to improve your cash flow in the medium and long term.
Don’t want to wait? Click here to get our guide, Happiness is a Positive Cash Flow and read all our tips and advice for achieving and maintaining a positive cash flow.
Get in touch to discuss your individual circumstances and get some independent, impartial advice on your business’s financial health.
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