Cash Flow or In trouble?

System
System Posts: 100,537 🤖 Admin 🤖
edited June 9 in General accounting discussion
I do the books for a building company ( and i've just completed Technician Level )

Recently cash flow has been a bit of an issue.

Is there a method of determining whether this is due to growth ( as we have been advised ) or if it is a problem looming - ie is the company in trouble?

I dont think its something i've come across in my AAT studies - unless I cant work out how to apply something?

Thanks

Amanda

Comments

  • System
    System Posts: 100,537 🤖 Admin 🤖
    Re:Cash Flow or In trouble?

    Lots of factors can cause cash flow problems, to name but a few:

    *Has there been an increase in assets
    *Has the owner drawn more cash than usual
    *Do you have a large aged debt list;
    and a small aged creditors list
    *How do your current KPIs compare with the previous year
    *Taxation increase

    Have you completed DFS? Have a look at the cash flow statement that is part of that module and apply it to your company's circumstances.

    Regards

    Dean
  • System
    System Posts: 100,537 🤖 Admin 🤖
    Re:Cash Flow or In trouble?

    Depending on what systems you use and how much you are expected to do in this role, you may find it worth working the actual against a budget. You will know that the budget won't lead you into difficulties (hopefully !) and therefore you can use this as a measuring stick against actual and the variances will tell you where the unexpected problem is. Even if the company don't work to a budget - historical data should be a good yard stick.
  • System
    System Posts: 100,537 🤖 Admin 🤖
    Re:Cash Flow or In trouble?

    If a company is in trouble then usually the symptoms commence with either sustained losses or seeing a substantial profit reduction. The company needs to finance that loss somehow. If it isn't through capital introductions from the directors/sole trader or bank finance, then usually what happens are trade creditors increase, VAT/PAYE usually get deferred and the bank overdraft usually increases (invariably to its limit). This is a common sign that the company is in decline. If you have done DFS then I would suggest looking more at the liquidity and profitability ratios rather than the cash flow statement.

    If the company is undergoing a period of growth then one would expect to see increased sales giving rise to increased debtors and possibly increased creditors as a result of increased purchases. You could possibly expect to see a rise in gross profit margins which could be representative of bulk purchase discounts. In the early stages of expansion, debtors could well increase due to increased sales (the credit control function can be monitored by performing a debtor days calculation) and the bank balances would decrease as more money would be tied up within debtors. Working capital requirements therefore would normally increase during the early stages of expansion so whilst profits would essentially increase cash may suffer in the early stages.

    It is important to understand, however, that whilst a company may appear to be making healthy profits - if cash isn't available to meet the expansion rate then this could be highly detrimental so it is common for most businesses to finance their planned expansion rather than relying on free cash flow. If your client's problem is through growth, the chances are they were attempting to finance it through free cash flow which hasn't been a feasible commercial decision.

    Kind regards
    Steve
  • System
    System Posts: 100,537 🤖 Admin 🤖
    Re:Cash Flow or In trouble?

    thank you vey much for your replies - very helpful.
  • System
    System Posts: 100,537 🤖 Admin 🤖
    Re:Cash Flow or In trouble?

    peugeot wrote:
    If a company is in trouble then usually the symptoms commence with either sustained losses or seeing a substantial profit reduction. The company needs to finance that loss somehow. If it isn't through capital introductions from the directors/sole trader or bank finance, then usually what happens are trade creditors increase, VAT/PAYE usually get deferred and the bank overdraft usually increases (invariably to its limit). This is a common sign that the company is in decline
    Steve has perfectly described the situation that my company is in. I'm constantly struggling to pay the Revenue and coming under never ending pressure from creditors. It isn't pleasant seeing as this is my first real job in accounting and I'm now continuously questioning myself whether I want to continue doing it or not.

    Having suspected I know where the problems are, I employ ratio analysis, mainly cost of sales (materials and labour) against revenue. I'm quite happy with the overheads since these are something I can have direct influence over or at least know when they are genuine.

    Watching cost of sales alarmingly rise against revenue over a period of time confirms mine and the previous Financial Controllers long-held suspicions that the company is "missing" sales with jobs being sold straight for cash at the highest level. In other words, materials and direct labour resources are being used as always but just aren't being converted into legitimate recorded sales. Since we handle large volumes of cash, I would imagine this is a very common sign that the directors are milking their own company and funds are possibly being 'diverted' elsewhere.

    Horrible situation and a real trial by fire.

    Regards,

    Robert
  • System
    System Posts: 100,537 🤖 Admin 🤖
    Re:Cash Flow or In trouble?

    In the event of a corporation tax enquiry such a practice will, almost undoubtedly, come to light. The fact that Inspectors of Taxes are now being paid bonuses relating to the amount of unpaid tax they recover means OMB's are more prone to investigations (whether an aspect enquiry or full enquiry) than ever before.

    Unfortunately, my experience tells me that some company directors have the attitude "my company my money".

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