Cashflow is the money going in and out of the company. Being aware of and managing cash flow is crucial for consultancies for financial stability.

Firstly, although consultancy requires very little upfront investment compared to product companies for example, cashflow is necessary to pay salaries and contractor payment. Bearing in mind that consultancies pay their permanent employees before they receive payment for the work that they perform, there is always a need for a cash buffer equal to at least the cost of the monthly salaries total, but more likely more.

Primarily a healthy cashflow allows consultancies to effectively manage their working capital. Working capital refers to the funds required for day-to-day operations, including project expenses, overhead costs, and other operational needs.

It also provides valuable insights for planning and forecasting. By analysing historical cash flow patterns, consultancies can make informed decisions about future investment needs or make decisions on what to do with surplus cash.

In addition, cashflow budgeting It enables them to anticipate future cash needs and take proactive measures to address any potential shortfalls or cash flow gaps.

Finally, some Consultancies may rely on external funding sources or maintain credit lines to support their operations. Proper cash flow management helps in servicing debts, paying interest, and managing financial risks associated with borrowing.  Poor cash flow management on the other had means potentially becoming a bad payer to your bank (or being in breach of other covenants see below) and can have adverse effects on the company from additional reporting  requirements to eventual restructuring.

Covenants

Covenants are agreements with your bank to maintain a certain financial integrity over and above simply paying debt. These might include:

• Financial Ratio Covenants where Banks may require the borrowing company to maintain specific financial ratios, such as debt-to-equity ratio, current ratio, or interest coverage ratio.
• Debt Service Coverage Ratio (DSCR) Covenant that ensures that the company generates sufficient cash flow to cover its debt payments.
• Limitations on Dividends and Distributions to ensure that the company retains sufficient funds to meet its loan obligations and maintain financial stability.
• Reporting Requirement including regular financial reporting from the borrowing company, including audited financial statements, cash flow projections, and other relevant financial information.

Its often rapidly scaling consultancies who have debt to service or potentially those who have been acquired by other companies who leverage debt which is laid on the purchased organisation rather than a cash purchase.

Managing Cashflow

Assuming you are running an overall profitable business (and as a consultancy you should be) tbhen simplistically there are only two principles to managing cash flow effectively . These are ensuring that the timing of outward payments are controlled  and ensuring that timing of outward payment is controlled.. Put simply don’t pay too early and don’t receive money too late.

The complexity comes in the real world application of these principles. There are a number of typical situations which consultancies encounter that have the potential to affect the health of the company’s cashflow.

Cashflow considerations

• Firstly, your clients may well need to manage their cash in exactly the same way. This is certainly the case If you are dealing with other service providers. Each set of contracts for clients will have their own payment terms, which regularly state that payment for work is between one and three months after the date of invoice, or seen after the final day of the month in which the invoice refers to. This can lead to anything up to four months elapsed time between work performed and money received. Its always an option not to sign up for extreme versions of these terms, but realistically they are so standard, that to do this regularly would probably significantly reduce opportunity growth.  Realistically, therefore you need to build your working capital so that this offset is built into your financials and you are able to pay your outflows in the meantime.
• Another element are the client rules for payment contained within their internal processes. This typically means consultancies need to ensure invoices are generated in a timely manner, are accurate, sent to the right person an including all the relevant agreed details, including rates, who performed the work, when  and any purchase order number. Depending on the flexibility of your client, any errors in this paperwork may well result in payments stalling, regeneration of invoicing and the clock starting again.
• Next, there are cash considerations as a result of otherwise positive events. Winning a large client or other outcomes resulting in rapid scaling, mean there are suddenly large demands on cash to pay for resources before the equally large influx of cash from client payment. This is one reason why scaling with contractors is so attractive – you may be able to tie their payment in with yours.
• Another potential problem comes when agreeing outcome-based pieces of work. These agreements often tie payment to milestones, with total payment against final deliverables.  Whilst this has the advantage of control for the consultancy, any delays or quality issues, even if the consultancy is not at fault, can delay payment considerably.
• Finally, from time to time you may come across a client who is a bad payer, either is regularly late or goes through a period of being unable or unwilling to pay. Depending on the size of client this will have impacts on your cashflow situation. So what to do with a bad payer?

It would make sense not to do business with bad payers but this might also not be desirable or possible, as the revenue upside is attractive and  you usually find you are in this position after having engaged and signed, and having committed resources or delivered work. There are a few considerations for risk reduction here. You may be able to credit check the organisation prior to commencing work, put terms into the agreement to apply interest on late payments, insist on higher rates as insurance, or tie in any discount or value-add to prompt payment.

Measuring Cashflow

How do you give yourself comfort that have sufficient cash?

Days of Cash is a financial metric that indicates how many days a company can sustain its operations using its current cash balance, assuming no additional cash inflows. It’s a simple metric which is calculated using the following formula.

Days of Cash = (Cash and Cash Equivalents / Average Daily Operating Expenses)

A typical goal for consultancies to maintain is 90 days of cash. This provides the right balance between ability to weather unforeseen inflow gaps, and unused cash sitting with banks. This will be very dependent on individual circumstances and some companies may feel more comfortable with six months of cash on hand.

What do you do with too much cash? Its not great business practice to have too much cash sitting idly in low interest accounts though it certainly provides security Excess cash can be used to reinvest into business initiatives, put aside into interest or growth accounts, invest into other companies or paid to the shareholders. This is where holding companies come in. It’s their role (amongst others) to think strategically about how to use the cash generated by the business to generate even more money. Holding companies give clarity of responsibility, financial flexibility and asset protection.