Dangers of overdrafts: How to reduce and even remove the need for one!
There are many dangers of overdrafts for businesses. Many companies struggle with cashflow which is caused by late payments by clients and the need to pay labour weekly etc. The short to medium term lack of cash can causes many a sleepless night.
You may see or hear day to day cashflow referred to as, the working capital. One of the solutions to help boost this, is often to get an overdraft facility from your bank, but this can be dangerous if not managed.
So, what are the dangers of an overdraft?
Your overdraft can be withdrawn with zero notice
A bank will lend you an umbrella when the sun is shining and ask for it back when it begins to rain. The biggest one and the one that can come as a nasty surprise, is that the bank can withdraw an overdraft without any notice. And of course, demand immediate repayment of the money owed. This will normally result in a lot of businesses simply going into administration, unless they can find the money to repay the bank from elsewhere.
Business owners can easily fall victim to this when they are most vulnerable. For example when a building contractor has just won or started new contracts and are awaiting their 1st application payment, known as over trading.
You take your eye off the ball because you feel too comfortable
The next danger worth mentioning is the false sense of comfort given by the overdraft can lead to an over reliance. This results in a lot of businesses taking their eye off the ball when it comes to ensuring their clients pay them when they’re due and paying suppliers early when they hit their credit limit for example. The interest being paid should also be considered as it will eat into your hard earned profit and cash.
You can loss far more than just your business
The last I want to highlight is that very often to secure an overdraft from the bank they will not be satisfied with having just the company assets as security but will want personal assets or even your home as security. So if the worst happens and the business goes into administration you could lose your home as well, Please don’t let that happen!
Read on and I will explain some possible solutions.
A little planning can make all the difference
Anyone who has worked like myself in construction knows that the key to success lie in being able to plan your resources to be on time, on budget, on quality. By using some of that planning know-how and skills, very often cashflow issues can be spotted way ahead of them becoming a problem.
The first step is to have an accurate and realistic contract cost forecast based on the project program before agreeing the stage payment values, this will allow a closer match between cash going out and coming in.
Also, don’t be tempted to try and claim to much in the early stages as front loading payments will just result in cash shortfalls later on in the project.
Make sure you keep a laser eye on the big picture
The combined project forecasts should be consolidated to form an overall cashflow forecast, but this can’t be a static document it needs regularly reviewed and compared to actual cashflow.
The key to making this solution work is twofold firstly having up to date information and thanks to cloud accounting with its daily bank feeds the type of information only previously available to the big main contractors is now readily available by everyone! But secondly having this information is useless unless someone is monitoring this, and again cloud software allows not only you, but also your Accountant to monitor this for you, a service your accountant will hopefully be able to provide.
With a realistic and up to date cashflow forecast along with monitoring software triggering advanced warnings of cash shortfalls these can be planned and managed.
Keep the money rolling in
The cheapest way to relieve your cashflow is to reduce the amount of time it takes clients to pay you. This means having an ultra-efficient application for payment/sales invoicing process which also makes paying really easy. Simply procedures like making sure your client or suppliers have your bank details for electronic transfer. It is also very important you have provided your CIS details (when necessary), and understand the process you need to follow i.e. who applications go to, making sure your order number is added etc. Also worth considering accepting payment via cloud based online payment services or even card payments.
Make the most of credit facilities
The next is to manage your supplier accounts to gain the best credit terms possible by looking for higher credit limits and more time to pay ideally 60 day end of month following but at least 30 day end of month following. But to gain these sorts of terms you must first build the trust of your suppliers by staying within your limit and paying on time this is another benefit of having both cloud accounting and regular monitoring flagging up when things are due.
These are just a few of the solutions available before you may need to consider an overdraft.
Feel free to contact me if you want to discuss further or are interested in our finance business partner service to help you manage your cashflow better.
If you think that our business advisory and accountancy services could be of interest to your business please contact us using the details below. We can arrange a consultancy meeting at our office or on site. We look forward to hearing from you.
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