Managing a Business and Finance

Improving Cash Flow

Improving Cash Flow

Businesses need cash for:

Business Studies A Level - Cash Flow– Set-up

– Day-to-day trading

– Growth

The shorter the cash flow cycle, the lower the value of working capital that needs to be financed by other sources.

The working capital cycles can be shortened by:

      • Reducing stock levels (thereby lowering the period of time stock is held)
      • Speeding up the rate at which debts are collected

The main causes of cash flow problems include:

Business Studies A Level - Empty Pockets Low profits and profit losses: the most important source of cash for a business is profit. There is, in fact, a direct link between low profits or loses and cash flow problems. In the end, most loss-making business eventually run out of money.

– Over-investments: this is where too much money is spent on fixed assets. It’s difficult to turn fixed assets back into cash and taking out short-term finance, like a bank loan, to pay for it will exacerbate the cash flow situation.

– Excess stock: stock amounts to tied up cash. Bulk buying usually means that the cost per unit is lower and there must be enough stock to meet customer demand. However, unsold stock runs the risk of becoming obsolete.

Allowing too much customer credit: customer who buy on credit are known as ‘trade debtors‘. Offering credit is a good way to build sales however late payments are a very common issue.

– Over-trading: this is where short-term finance is pushed to it limits because a business expands too quickly. Choosinesses which have a long-term contract also run the risk of over-trading.

– Seasonal demands: if a business knows they’ll be a greater demand for its product at a particular time of year it tends to purchase and produce in advance. Cash flow forecasting can be used to ensure that the money is available.

– Unexpected changes: this includes internal change (for example, key worker are lost or machinery breakdown) or external change (for example, a major accident or economic downturn).

Improving cash flow

There are a number of ways cash flow can be improved:

Short-term:

– reduction of current assets

– increase of current liabilities

– selling of surplus fixed assets

Long-term:

– increase of equity finance

– increase of long-term liabilities

– reduction of net outflow on fixed assets

Business Studies A Level - Cash Flow ImprovementsPrice discounting is another option as cash can be generated through an increase of sales and stock levels are also reduced. However, the business’ pricing structure could be undermined and the business left with low stock levels. Plus, the success of this method depends on price elasticity of demand.

Many businesses opt for a bank loan or overdraft to help see them through a cash flow problem. However, nowadays this option has become much harder to obtain.

Selling spare assets can help provide a short-term boost, for example excess land or spare equipment. However, not too many businesses have spare assets lying around.

Instead, a business could consider sale and leaseback in which they sell a fixed assets then have the new owner lease it back to them. This is more common with business properties, for instance office or hotels.