They say cash is king, and running a business of any kind is certainly easier with more cash. Cash gives you a safety net and options. And, as a contractor or consultant, the more cash you have in your business, the longer you can weather any storms – such as the fallout from coronavirus.
What is a cash flow forecast, and why do you need one?
A cash flow forecast is really straightforward: it tells you for a given month how much cash you’ll have to hand – i.e. in the bank. For contractors and consultants, we recommend that you create two cash flow forecasts – one for your company, and one for your personal cash flow.
For your company, your starting point will be the cash you have in your business bank account today. Then, for each month, you’ll build a forecast by adding all the money you expect to receive into your company (typically from payment of your invoices), minus all the money you spend or draw from your business (e.g. salaries, dividends, bills and tax payments).
For your personal cash flow, your starting point will be the cash you have in your personal bank accounts. The principal is similar: for each month add the net income you receive from your company (via salaries and dividends), and minus your personal expenditure (e.g. mortgage payments, bills, and self-assessment tax payments).
You can use these cash flow forecasts to tell you how long you can continue to operate for with a reduced income. It’s a tool for modelling risk.
In times of uncertainty, you’ll be wise to keep a close eye on all the cash coming in and going out of your business and personal accounts and do what you can to improve cash flow. It might help to think of cash flow as a water butt – you’re trying to fill it as quickly as possible when it’s raining, whilst slowing the flow out as much as possible. This means, as a rule of thumb, you’re trying to maximise your income, and receive it sooner, whilst looking to minimise your expenditure.
Take stock of your personal finances
For owner-managed businesses, personal and business finances often go hand in hand. How do you know if your salary and dividends are at the right level? In order to do this, you’ll need to understand your personal finances.
Your starting point should be to understand the minimum salary and dividends you can draw from your company to pay your bills, and continue with your preferred lifestyle. Times of uncertainty present an opportunity to review your and optimise your spending. Do you have scope to reduce your household expenditure? Can you find cheaper loans or mortgages, or cancel unused subscriptions? Can you be more prudent when it comes to supermarket shopping? If you have children at nursery or fee-paying schools, have you negotiated lower fees as a result of coronavirus? Check out Martin Lewis’ excellent website Money Saving Expert for tips and resources.
Once you’ve optimised your personal cash flow, you can set your salary and dividend drawings to an appropriate level. By keeping cash in your company and paying yourself a reduced yet regular salary and dividend, you may find it easier to stick to budgets.
Calculate the size of the ‘war chest’ you need
A ‘war chest’ is cash (typically held in your company) that acts as a buffer should you not be earning. It’s an important part of being a contractor or consultant and allows you to survive lean periods or downturns with minimal impact.
Paul, our CTO is a former contractor, and had a creative approach to his war chest: “I worked on the principle of being able to survive for a year. In my plan, I gave myself permission for the first 3 months to have additional spending on fun stuff – an extended vacation! The next 3 months were budgeted for serious contract hunting, and the final 6 months, if I needed them, allowed me to live stress-free with a little belt-tightening.”
Experiment with your personal cash flow model, and you should be able to arrive at a figure for the salary/dividends you need for your personal war chest. You can then use this number in your company’s cash flow forecast to set a target for how much cash you need to keep in your company’s bank account.
Start with a 6-month forecast
Given the turbulence in the economy, we recommend at least building a simple company cash flow forecast for the next six months. It’s worth doing this even if you’re currently in a contract because, in uncertain times, the contracting and consulting market can move quickly. It doesn’t need to be overly complicated – ten lines in a spreadsheet should do it:
|April 2020||May 2020 etc|
|Opening bank balance|
|Expenses and bills||–|
|Salary payments (net)||–|
|Income tax and NI (every m or 3m)||–|
|VAT (every 3m)||–|
|Corporation tax (every 12m)||–|
|Closing bank balance||=|
|(Target bank balance)|
When you create a cash flow forecast, all your figures should be inclusive of VAT – which makes the process much easier. The three tax lines (income tax/NI, VAT and CT) should be populated the month that the tax payments are due to be paid, otherwise leave them empty. Your target bank balance should be based on your personal war chest goal.
With your forecast, you can see how your bank balance will change over the coming months. Are you increasing it and getting closer to your war chest goal? It is depleting – if so, how quickly? Once you have a simple cash flow forecast you can then experiment to see how you can improve it by using the following suggestions.
Work more / invoice more
Many companies are experiencing a productivity hit due to sickness and permies with childcare constraints – can you help your client by working (and invoicing) more? This could allow you to maximise your income.
Previously clients were very rigid about aligning contractor and consultants working hours around a typical working week in the office. However, given the majority of contractors and consultants are now working from home, is there scope to increase the number of hours you’re working for your client?
Get cash in quicker, and manage late payments
Best practice for good cash flow management is getting cash into your business as quickly as possible. What are your current terms from invoice to payment with your clients? Can you negotiate this down? Do your clients normally pay on time? Do you charge them penalties for late payments? If you negotiate payments down from 90 days to 30 days, you’ve created an instant two month buffer, with minimal effort.
In response to coronavirus, many large companies are speeding up their payment processes for small suppliers – which is good news for contractors and consultants. You may want to check in with your procurement contacts to see if this could benefit you.
Consider invoice factoring (carefully)
If your client has particularly long payment terms, you may wish to consider invoice factoring. This a loan that’s granted based on the value of your invoice, and is paid to you when you raise your invoice. When the client finally settles the invoice, the payment is made to the invoice factoring company. Invoice factoring can be expensive, and may not give you long term gains. You may find cheaper means to borrow in the short-term, for example by delaying your VAT payments or self-assessment payments on account.
Get a cashback credit card
If you’re able to clear credit card bills each month in full, then consider looking for a cashback credit card, or other cards which offer rewards.
Trim your pension payments
You may need to trim back on your pension payments – but keep in mind that you might want to top up your payments again before the end of the tax year in April 2021 – so you won’t lose your annual pension allowance.
Claim for home office expenses
This won’t help short-term cash flow, but it will reduce your corporation tax. Given you will find yourself working from home more over the coming months, consider increasing how much you claim for your home office expenses. Remember these are an allowable deduction, reducing your corporation tax bill. You’ll find more on home office claims here.
Consider payment deferrals carefully
In response to coronavirus, there are many opportunities to defer payments. For example, you may have deferred your VAT payment and your self-assessment payment on account. If you’re struggling to pay your corporation tax, HMRC can set up a monthly payment scheme. And if personal finances are tight, banks are offering loan and mortgage holidays.
All of these mechanisms are simply deferrals: the original balance will still be due and need paying at some point. They could allow you to quickly build a safety net, but this will be short-lived unless it’s accompanied by an aggressive plan to cut outgoings and/or improve income.
To model a payment deferral in your cashflow forecast, simply move the payment amount to the right by a number of months. Alternatively, you can model the impact of VAT and corporation tax deferrals quickly in Livecash by simply unchecking the amounts due. (See diagram).