Key points
- A cash-flow problem is a timing gap between money going out and money coming in. It can exist in a profitable business.
- The usual causes are slow-paying customers, cash tied up in stock, seasonality, fast growth and tax bills landing in lumps.
- Credit control, deposits, supplier terms and pricing often close the gap faster and more cheaply than finance.
- Invoice finance, cash flow finance, working capital finance and an arranged overdraft each suit a different shape of gap.
- If the gap never closes, the business has a debt or profitability problem, and finance will not fix it.
Profitable but cash-poor: how it happens
Accounts record a sale when the invoice is raised, not when it is paid. They record stock as an asset, not as cash that has gone. So a business can be profitable on paper while its bank account tells a different story. The gap is called the cash conversion cycle: the number of days between paying for materials, stock or staff and receiving cash from the customer. The longer that cycle, the more cash the business needs just to stand still, and the faster it grows, the worse the squeeze.
The main causes
- Debtor days. If customers are given 30-day terms and pay in 60, the business is lending them money. One large customer paying late can empty the account on its own.
- Stock. Every pound on the shelf or in the warehouse is a pound not in the bank. Over-ordering to secure a discount, or holding slow-moving lines, ties up cash for months.
- Seasonality. Hospitality, retail, construction and tourism businesses often earn most of their income in a few months and carry fixed costs all year.
- Growth. A new contract means more staff, more materials and more invoices outstanding before the first payment arrives. Growth consumes cash before it produces any.
- VAT and corporation tax timing. VAT is collected gradually but paid quarterly. Corporation tax is paid nine months after the year end, often when the profit it relates to has long since been spent. Both arrive as lumps.
Operational fixes to try before finance
Finance costs money. These changes cost mainly effort, and several of them shorten the cash cycle permanently.
- Credit control. Invoice the same day the work is done. Chase on the due date, not a fortnight later. Make it one person's job and measure debtor days monthly.
- Deposits and stage payments. A deposit on order and payments at agreed stages move cash forward and reduce exposure to a single late payer.
- Supplier terms. Ask key suppliers for 45 or 60 days, or for a trade account where you currently pay pro forma. Paying later, by agreement, is free finance.
- Pricing. Many cash-flow problems are margin problems in disguise. A small price increase on the right lines can do more than any facility.
- Stock discipline. Cut slow lines, order little and often, and sell through dead stock even at a discount.
- Tax set-asides. Move VAT collected and a share of profit for corporation tax into a separate account each month so the bills are already funded.
Our guide on how to improve business cash flow goes through each of these in more detail.
Finance options and what each one suits
| Option | How it works | Suits | Watch for |
|---|---|---|---|
| Invoice finance | A provider advances most of the value of unpaid invoices, then the balance less fees when the customer pays. Factoring means the provider collects; invoice discounting means you do. | Businesses selling to other businesses on credit terms, where debtor days are the main cause. | Service fees and discount charges; concentration limits on single customers; some contracts are hard to exit. |
| Cash flow finance | A loan or revolving facility sized against trading cash flow rather than specific invoices or assets. | Businesses with steady income and a predictable, short-lived gap. | Usually a personal guarantee; rates reflect the lack of security; short terms raise the monthly cost. |
| Working capital finance | Funding for day-to-day operating needs such as stock, wages and supplier payments while awaiting receipts. | Seasonal or growing businesses that need a buffer for a defined period. | Adds to total borrowing; the need recurs if the underlying cycle is not shortened. |
| Arranged overdraft | A flexible limit on the business current account, repayable on demand. | Small, occasional dips of a few days or weeks. | Can be withdrawn at short notice; becomes expensive and permanent if used every month. See business overdraft debt. |
The right choice depends on where the cash is stuck. If it is in unpaid invoices, invoice finance releases it directly. If it is in stock or seasonality, a working capital facility with a term that matches the cycle may suit. A general loan used to cover a structural gap tends to be re-borrowed every year.
When a cash-flow problem is really a debt problem
The test is simple. Build a 13-week cash-flow forecast and extend it to a year. If the gap closes, because customers pay, the season turns or the tax bill passes, it is a timing problem and the options above apply. If the gap never closes, and the business ends every month with less cash than it started with, no amount of finance will change that. It will only add repayments to a business that cannot already cover its costs.
Signs that the line has been crossed include using new borrowing to meet existing repayments, HMRC arrears growing quarter on quarter, and the overdraft never returning to zero. Our pages on business debt problems and high loan repayments cover what to do next, and restructuring existing debt may be more relevant than new finance.
When to get professional or free help
If the business cannot pay wages, HMRC or suppliers when due, and the forecast shows no recovery, get help before borrowing. Business Debtline offers free, impartial advice to small businesses and the self-employed. GOV.UK explains how to contact HMRC if you cannot pay tax on time. Where a business cannot pay its debts as they fall due, a licensed insolvency practitioner may need to be involved. Finance Business Debt provides information only.
Frequently asked questions
How much cash should a business keep in reserve?
There is no universal figure. Many owners aim for enough to cover one to three months of fixed costs. A business with long debtor days or strong seasonality needs more than one paid at the till each day.
Is an overdraft or invoice finance better for late-paying customers?
Invoice finance is designed for that problem and grows with sales. An overdraft is simpler but has a fixed limit and can be withdrawn. For a persistent debtor-days issue, invoice finance usually fits better.
Can I get cash flow finance if I already have loans?
Sometimes, subject to affordability and existing security. If the existing loans are the cause of the shortfall, consolidation or refinancing is more likely to be relevant than another facility on top. See managing multiple business loans.
What is a 13-week cash-flow forecast?
A week-by-week projection of money in and money out for the next quarter, starting from today's bank balance. It is short enough to be accurate and long enough to show a VAT quarter and a payroll cycle. A spreadsheet is fine.
Can HMRC help with a VAT bill I cannot pay?
HMRC can agree a Time to Pay arrangement if contacted before or shortly after the due date. Interest continues to accrue. Our HMRC tax debt page explains how it works.