This article was originally published on 28 September 2023. The article was republished on 14 March 2024.

If you’re running your own business, you’ll appreciate the importance of having enough money coming in to cover your outgoings. But what if your income halted temporarily or you had escalating costs (think trade tensions affecting your suppliers and the recent energy prices shock). How long could you manage to pay all your expenses?

Emily Coltman, chief accountant to award-winning* accounting software provider FreeAgent, points out that the business world is hard to predict: “What if you have unexpected bills or your main customer has a cash-flow problem and can’t afford to pay you?

“One company going out of business could mean those further down a huge chain are suddenly affected, so it makes sense to have that cash buffer. Then you can at least pay your staff, keep your business going and keep trading to bring in the money to pay the next bills.”

The whole point of building a safety net of cash in the bank is that it can be accessed easily in case of an emergency. An account with instant access is ideal.

“I’ve heard of people investing their money into fine wines or an art collection but something like that is only a reliable asset if there’s a market for it: what if nobody wants to buy the paintings when you need to sell them? Cash it should be. Nothing else,” says Emily.

As a general rule, businesses might aim to build up a cash reserve to cover between three and six months of day-to-day operating expenses to bridge a challenging period, but this will depend on various factors:

• The size of the business and overheads: are there staff to pay each month or utility bills related to office/premises/factory/machinery.
• Industry: a retailer with a seasonal business, for example, might have expenses clustered into six months of the year and will need to budget accordingly. Whereas an IT or freelance marketing consultant would only have their own wages to pay and may not need as big a cash reserve.
• Inventory management: a company might purchase stock once a year or it might have a high stock turnover and be paying out regularly.

Here are three key elements that comprise the building blocks of a cash flow forecast, along with a link to other accounting terms you may come across such as working capital (the difference between your current assets and current liabilities).

1. Start with a sales forecast: Just as it sounds, this is a prediction of what you’re going to sell – and when.
2. Profit and loss statement: This aims to show whether the business’s income is higher than its day-to-day costs. Here, you start with your sales forecast and then take off all of your business’s day-to-day running costs, including outgoings that you pay for personally, costs from your business account and upcoming costs.
3. Cash-flow forecast: This is a prediction of how much a business expects to see coming in and how much is going out. At this stage, you would include any new equipment you plan to buy, as well as items like debts and taxes that will need to be paid. 

Accounting software like FreeAgent provides templates for these statements and can help you keep track of your forecasting, along with admin reminders for items like tax and invoices. FreeAgent is included for our business banking customers as long as they retain their bank account. Specific account eligibility apply.

Emily says that a separate business account could help keep things simple, particularly for those business owners who might forget to track the money they spend. “It’s so easy to overlook the costs if you’re not spending it out of your business bank account.” Not only can businesses not reimburse owners who don’t keep track of their spending, but there’s also a tax consideration. “You pay tax on your profit (income less day-to-day running costs), and if your profit is too high then your tax will be too high,” she adds.

Ensure you have the right bank account for your business so you can check that money has gone in and out quickly, while also offering a quick and easy way for customers to pay you.

Our savings accounts provide a separate place to help avoid dipping into your cash buffer. Bear in mind that there are different business savings accounts, depending on whether you want instant access to your cash or if you’re happy to lock your money away for a set period. Criteria apply.

• Draw up clear and concise invoices with payment terms
• Stock taking: by planning ahead you can earmark a certain amount of money to spend on stock while ensuring you don’t actually run out
•  Carry out creditworthiness checks on your customers and your suppliers
• Chase late payments

• Consider leasing equipment instead of buying outright
• Review and if necessary cancel subscriptions or outdated expenses
• Liaise with suppliers for timely payments going out or bulk buy (perhaps by teaming up with other businesses)

* Institute of Certified Bookkeepers LUCA 'Friendliest Software' award 2023.