Staying on top of cash flow is essential for any business, but it can be particularly challenging for sole traders. This is because as a sole trader, you are in charge of both bringing in money and paying bills – there is no one else to share the load. Even if your business is running a profit, it only takes one unexpected illness or a couple of slow trading months to put you in the red.
Sole traders are also at risk of something called overtrading. This is a bizarre situation where, if your business is thriving, there’s an even greater danger it could run out of cash. For example, if you accept a £20,000 order which requires you to pay out £10,000 in materials, there’s a good chance you’ll have to fork out the £10,000 at least a month before the customer pays you the £20,000. If you haven’t planned for this, then it can quickly lead to cash flow problems.
Luckily, there are a few steps you can take to get on top of your cash flow and avoid any nasty surprises. Here are our top four.
1. Create a cashflow forecast
If you don’t know what’s coming into and going out of your business, and when, then how can you plan for the future? You may think that you’re making a healthy profit but if you don’t have the data, you’re just guessing.
Creating a cash flow forecast will give you a clear picture of what’s happening and help you make better decisions about your money. This is a simple chart where you track:
- Income – what you’re expecting to receive that month, when and from whom.
- Expenditure – this includes all the bills you need to pay out, such as office expenses and travel, and setting cash aside for tax and anything else you’ve committed to.
- Your month-end balance – what ended up in your account at the end of the month.
This can be done very easily with accounting software, although a simple spreadsheet can do just as well to begin with. The important thing is to track all the money your business spends and receives each month in one place.
2. Identify any problems
Getting an accurate picture of your current cash flow situation is the first step to helping you manage it better. Start by looking closely at your forecasts and what’s going on behind the numbers. Ask yourself:
- Can you see any patterns in your cash flow?
- Are there seasonal peaks and troughs?
- Do you have repeatedly late-paying clients?
- Do you agree on clear payment terms when signing contracts – and are those terms working for you?
- Are you chasing payments as soon as they are due?
- Are your monthly expenses proportionate and necessary? For example, are you paying for subscriptions or service levels you don’t need?
- Could you negotiate better credit terms with suppliers? The more time you have to pay your suppliers, the better your cash flow.
These questions will help you identify any potential issues and start to plan for them. You may find, for example, that a little proactivity on your part can make the world of difference. If your customers have 30 days to pay an invoice, why not send a polite nudge after 20 days? This could help you get paid on time and avoid any nasty surprises.
3. Make sure you are invoicing correctly and regularly
If you want to get paid on time, it is important to make sure that you are invoicing correctly. This sounds like a no-brainer, but you would be surprised how many sole traders get it wrong.
There’s some information that you must legally include on your invoices. Ensure your invoices are formatted correctly with invoice date, unit prices, VAT, due date and other details – some clients may refuse to pay an invoice which is not clearly laid out, and you may not be able to enforce payment if the invoice isn’t up to scratch.
It is always a good idea to send invoices out as soon as the job is done, rather than waiting until the end of the month. The sooner you can send out an invoice, the quicker you will receive your cash. The same goes for chasing invoices – if you don’t send out a timely reminder, then you could be sabotaging your chances of receiving the cash on time (or at all).
If you are using accounting software, you can set it up to automatically generate legally compliant invoices, send them for you, and issue reminders to customers who have outstanding payments. This is a great time-saver and means you don’t have to worry about forgetting to invoice someone.
4. Stay on top of your taxes
As a sole trader, it is your responsibility to make sure that you are paying the correct amount of Income Tax, National Insurance Contributions and VAT. This can be a challenge. When your income varies from month to month, it can be difficult to know exactly how much money you need to set aside for taxes.
As a rule of thumb, calculate your estimated income for the year and assume that taxes will amount to around 30%. Set aside a regular portion of each payment you receive as tax, based on this figure.
For a more accurate figure, use accounting software to track your income and expenses. This will help you to see exactly how much money you are making and what your outgoings are and will run calculations in the background so you can see how much tax you need to pay. You may have heard about Making Tax Digital, which is the UK Government’s move towards digital tax filing. Self-assessment taxpayers will have to comply with MTD from April 2024. Getting used to the accounting software now will make this transition a lot easier and is a good way to make sure you comply with the law.
Final Words
Managing your cash flow as a sole trader can be challenging but, with a few simple steps, you can make sure that your business is in a secure financial position and ready to grow. If you need guidance in setting up any of the above items, give us a call. We’re happy to help!
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