How to deal with a short-term business cash flow problem
Financial peaks and troughs are a part of business life. But the way that you approach a dip in income can have a big impact on your future finances.
This guide will help you understand your options when your business is short of cash. Learn more about short-term finance and what to do about paying it back.
Experiencing a cash flow problem? Here are your options
Before you jump into solution mode, take a step back and assess your situation. You need to be clear about what it is you actually need. Ask yourself:
- How much money do I need to borrow? Borrow too much and you’ll overpay on interest; borrow too little and it won’t be effective
- What do I need the money for? If it’s a one-off payment, could you buy it on your credit card and avoid the need for a loan, for example?
- Is there another way to free up cash? Look at your planned payments and see if you can delay any of them for a short time
- How long do I need the money for? Short-term loans are often much higher in interest. If you need help over a longer period then a long-term loan might be a more sensible option
Deferred payments
As the name suggests, a deferred payment is one that you delay until a later date. These can be helpful for small businesses that are affected financially by a couple of payments coming out of their account.
Start with a clear overview of all your payments over the course of the year. Then you can see where deferments could help to free up some cash.
Think about:
- Annual payments. You could arrange to pay these during your busiest months when income is higher. Or spread them out on a monthly basis instead
- Regular payments. Can you arrange to pay more in busy months and less in the quiet months?
- Payment terms. Can you agree longer payment terms with suppliers, or find other suppliers with fairer terms?
- Payment dates. Are you automatically paying invoices when they could wait longer under the payment terms?
- Payment holidays. Look at the terms and conditions to see if you can take a break from repayments for a short time
- Special deals. Talk to suppliers about any deals they can offer you, such as a discount if you pay up front
And it’s not just about making your own payments. Consider how you’re asking people to pay you, too.
Review your own payment terms. Identify any customers who are late payers to see if you can encourage them to pay you faster.
Baoli Zhao tries to secure longer payment terms and reduce expenses when cash is tight
“I suggest you regularly update your financial projection. Try to maintain a positive cash flow. Talk with your supplier about getting a higher credit limit and also longer payment terms. Manage your waste. Try to reduce your expenses as much as possible.”
Baoli Zhao, managing director of Allsee Technologies
Short-term finance
Short-term business loans usually last between three months and one year. You then pay off the full balance by the end of the term.
Banks prefer to loan money (and charge interest) over a longer period. That means these loans tend to have higher interest rates. Typical rates are around 5-10 per cent.
For this reason, it’s not a good idea to take out a short-term loan unless you’re sure you can make the loan repayments. Remember that these are higher as they’re spread out over fewer payments.
If you can make the loan repayments, short-term finance might be a good option. This is because you’ll pay off your loan quicker.
Also bear in mind that the application process is less drawn-out than with long-term loans. This means you can usually access your money much quicker.
If you decide to go down this route, make sure you understand the main types of short-term finance:
Term loans
These are the most common types of short-term loans. They work like a personal loan where you agree a loan term with the lender. This includes the interest rate and how long you have to pay off your balance.
Invoice financing
In this instance, the bank either buys your unpaid invoices or lends you money based on what you’re owed.
Asset financing
You use the loan to buy, lease or replace equipment for your business. For example, machinery and vehicles or office equipment like computers.
Susan Fiander-Woodhouse used asset financing to purchase specialist cheese-making equipment
“When we first identified our path to innovation through asset financing, it was because we knew there was going to be a surge in expected demand for British cheddar. With our specialist equipment now in use, and production levels of our cheese soaring, we have secured our very first deal with a major supermarket.”
Susan Fiander-Woodhouse, managing director of Blaenafon of Cheddar
Other types of credit arrangements
If you need cash quickly, a loan isn’t your only option. Depending on your situation, one of the following options may be more suitable.
Loans from friends and family
Sometimes the most obvious solutions are the best. Borrowing money from friends and family can be a useful way to get over a short money hump.
Just make sure that an agreement is drawn up, however informal. This should state the amount borrowed, how and when you make repayments, and any interest you owe.
Overdrafts
It may be possible to increase your overdraft limit if your bank believes that you’re able to pay back the overdraft.
It’s good practice to present a clear picture of your finances. This should include a cash flow forecast to prove that you know when money is coming in and out of your business.
If you’re asking for a large amount, or the bank isn’t sure that you can repay the extra amount borrowed, they may offer you a secured overdraft.
This means that they use a business asset, like property, as insurance against your loan. If you’re unable to repay the amount borrowed in a certain timeframe, the asset will be sold to recoup the money.
Credit cards
Are you still using a personal credit card for your business purposes? If so, taking out a business credit card could help with your cash flow problems.
Business credit cards often offer higher credit limits than personal ones. So with this option you may be able to arrange a higher buffer for your business.
The other advantage is that the charges could potentially count as an allowable expense. Check with your accountant to find out if you can deduct them from your taxable earnings.
Trade credit
If you trade with regular suppliers, you may be able to arrange a trade credit agreement with them. This means they supply you with materials and agree repayment terms for a later date.
The idea is that you’re given time to create your products from the raw materials. Then you can sell them to generate income before settling your invoice.
Paying back what you owe
Before you take out any loan, be clear about how you plan to pay it back on time and what will happen if you miss any payments. If you’re concerned about missing payments, it’s best to find another way to deal with your cash flow problem. Otherwise, it could end up spiralling out of your control.
The best way to get back to cash flow parity is to learn how to even out your finances. This way, you’re more prepared when the money stops coming in.
Our guide on how to deal with seasonal fluctuations in your company cash flow explains how to budget and make a cash flow forecast.
Repaying your business loan
If you’ve taken out a short-term business loan, the lender will have asked for evidence that you can pay back your loan. Sticking to the plan you made is the best course of action to ensure that payments are made on time.
Paying back your loan on time helps you to:
- Keep a positive credit rating
- Maintain a strong relationship with the lender
- Remain in an eligible position to borrow again in future if necessary
- Protect your assets if you have a secured loan
- Avoid extra interest charges
- Reinvest money back into the business once you pay the loan off
In some cases, you may be able to afford to make overpayments. That means you will pay off the loan quicker. Be sure that:
- Your lender doesn’t charge early loan repayment fees
- Your loan doesn’t have a cap on how much you can overpay
Always keep your overpayments within the terms of the loan to avoid unnecessary charges.
What if you can’t repay your loan?
The rates applied, penalties and terms of a loan all vary between different products. It’s important to be aware of the consequences should the worst happen.
As a guideline, these are the general steps that lenders often follow when you miss payments:
- Failing to meet a payment date: you may incur an extra charge. This is based on a percentage of your regular installments. Administrative costs may also be added
- Failing to meet several loan payments: this is known as “defaulting” on a loan. It usually applies when you miss more than one payment, but sometimes one missed payment is seen as defaulting
Defaulting on your loan can cause serious problems for your business. It often leads to a negative credit rating, which can stay on your company’s file for years. This can affect your chances of future funding or investment.
If you’ve taken out a secured loan, you also run the risk of losing the assets which are tied to the loan. For example, if you used a property as an asset to secure the loan, it could be repossessed.
In extreme cases, lenders may take legal action. This is so they can recover the value of the loan as well as any outstanding interest, fees, and costs.
Coming to terms with a cash flow problem
A cash flow problem can be a shock to the system. It’s normal to want to leap into action and fix it quickly before things get worse.
However, it’s crucial to stop and research your options first. There’s plenty of support available, but not everything will be the right fit for your business.
Take some time and speak to a financial advisor if you aren’t sure. You want to be confident that the option you move forward with is the best one for your situation.
