Cashflow Statement versus Profit and Loss

Profit
and Loss accounts show the profitability of a business, cash flow statement
shows the flow of money into the business.

It
is possible and does quite often happen that a business can be making a profit
yet the business fails because of lack of cash flow.

One
of the major reasons for this could be customers (debtors) paying late and your
client not having a good credit management system in place. If the business
suppliers/creditors insist on payment and there is not money in the business to
pay they could file bankruptcy or insolvency proceedings and this would end up
in the closure of the business.

It
could be that your clients business is very profitable.

Businesses
can and do survive by, not making a profit however NO business can survive with negative cash flow for a
prolonged period.

The
way I like to look at it is lack of profits is like coastal erosion (slowly
eroding away but giving time for remedial action to remedy the situation) lack
of cash flow is like breaking the cliff away with dynamite!

Sometimes
cash flow is failing and cash flow shortage can be corrected by lending from
external sources, owners increasing equity in the business, negotiating better
credit terms with creditors or bringing in other investment (possibly by
selling part of the equity in a business).

In
order to get such injection of cash it’s normally important for the shortage of
cash flow to be forecast in advance, it’s unlikely that a business that ends up
in a cash flow crisis will be able to sort things out quick enough. Your role
in assisting your clients may include cash flow planning or simply notifying
your clients when debtors are overdue and giving them the information to help
them pursue the debt.

Also
by supplying the client with a summary of creditors and the bank balances helps
them work out what they can afford to pay and to prioritise the payment of
creditors.

Also
bear this in mind with your own practice (it’s no good being busy if customers
aren’t paying on time) you can’t pay your creditors with invoices you need
payment.

What can be done if
things start to go wrong?

The
earlier your client deals with the issue the better I cannot emphasise this too
strongly.

Clients
inevitably ‘bury their heads in the sand’ and don’t face up to the problems
before it’s too late. You as a bookkeeper will have the information before most
other professional advisors and as such you can provide a good early warning to
them.

Help
is often available and even if the client cannot get funding or sell equity
there are still a number of options open to the client.

Debt Management
Arrangement

is an informal agreement between your client and its creditors. This your
client could do or if your client prefers could ask you to do. You simply need
to contact the creditor (if your client asks you to) and discuss arrangements
for payment of the debt. If this is done early enough and the Client has a good
working relationship with the creditor then they will most probably agree to
some reasonable resolution. The other option is to appoint a debt management
firm to manage this on your client’s behalf (we can assist in this if your
client wishes)

CVA (Corporate Voluntary
Arrangement) is an agreement where your client would enter an agreement with
its creditors and arrange a repayment of part of the debt over an agreed
period of time and the balance is written off. This option is available to
Limited Companies or Limited Liability Partnerships. This is supervised by a
Licenced Insolvency Practitioner.

IVA (Individual Voluntary
Arrangement) is an agreement where your client would enter an agreement with
its creditors and arrange a repayment of part of the debt over an agreed
period of time and the balance is written off. This option is available to Individuals
which includes Sole Traders or Partnerships. This is supervised by a Licenced
Insolvency Practitioner.

Bankruptcy is an order passed by a court to ‘wind up’ the assets of an Individual which includes Sole Traders or
Partnerships. This would mean the court appointing an official receiver who
will collect in the value of all the assets owned by the bankrupt Individual
which includes Sole Traders or Partnerships and repay as many of the debts as
possible. This would mean the person ‘looses’ all their assets (some items are
exempt from this such as tools of your trade i.e. the items reasonably needed for
the client to earn a living). The bankruptcy would normally be discharged after
a year. During the period of bankruptcy, the client would be subject to certain
restrictions such as restrictions on how much they could borrow and they could
not be a director of a limited company. They would also have to declare their
earnings and a proportion can be taken from them in order to pay off their
debts. It’s a criminal offence for any person to hide or wilfully remove assets
prior to the bankruptcy (so please advise you client against a sudden spending
spree prior to a bankruptcy)

Insolvency is a process to ‘wind
up’ the company and use the assets of the Company to pay off the creditors.
This would mean the holding a meeting of creditors so that a vote can be made
to appoint an insolvency practitioner who will collect in the value of all the
assets owned by the insolvent company which and repay as many of the debts as
possible. In practice, the client would appoint an insolvency practitioner who
would assist in organising the meeting of creditors or the process would be
initiated by a creditor is the client does not settle its obligations. This
would mean the company closes and all their assets disposed of. The Insolvency
Practitioner would then assess the conduct of the directors before the
Insolvency happened and make a report to the Insolvency Service, in the event
of the Insolvency Practitioner not being happy with the conduct of the company
officers then the insolvency service could have the director(s) disqualified
from being a director for a number of years. It is a criminal offence for any
person to remove any assets or do anything to disguise their true value.

Administration is a process where an
administrator is appointed to run the company to ascertain the best resolution
for creditors which can include the sale of the company as a going concern.
This can sometimes be that the directors or shareholders buy the company back
without the encumbrance of the previous debt. This would normally be carried
out by the client calling in a licenced insolvency practitioner who will be
appointed as administrator.

If
your client is wishing to look at IVA, CVA or insolvency or administration we
can normally assist by helping with appointing an insolvency practitioner from
our panel. For a bankruptcy, your client needs a form available from the
Insolvency service or courts.

(Please
note the process is Scotland is slightly different than stated above and at present
we do not have any firms on our panel that will be able to assist).

Just
remember the more proactive you are and the earlier you or your client acts then the
quicker and more effective a solution can be.

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