5.8 - Improving Cash Flow
Causes of cash flow problems
Businesses often encounter issues with cash flow, where the money coming in does not match the money going out in time.
Factors that lead to cash flow difficulties
- Insufficient planning - Without proper cash flow forecasts, businesses fail to anticipate future shortages.
- Ineffective credit control - Poor management of customer payments results in overdue invoices and undetected bad debts.
- Extended credit terms for customers - Granting too much time for customers to pay improves their cash position but delays inflows for the business.
- Rapid expansion - Growing too quickly, known as overtrading, requires upfront payments for higher costs like stock or staff, long before extra sales generate cash.
- Unforeseen circumstances - Sudden rises in expenses, such as unexpected repairs or price hikes from suppliers, can create negative cash flows that were not predicted in any planning.
Methods of improving cash flow
Improving cash flow involves strategies to either boost the money entering the business or cut back on the money leaving it. These methods focus on the short-term cash position, and some may initially worsen cash before providing benefits.
Methods to increase cash inflows
Businesses can enhance inflows by accessing quick finance or speeding up payments from customers.
| Method | Description | Drawbacks |
|---|---|---|
| Overdraft | A flexible bank arrangement allowing borrowing up to a set limit as needed. | High interest charges apply, and the bank can withdraw the facility at any time. |
| Short-term loan | Borrowing a fixed sum for a specific period to cover immediate needs. | Involves interest payments and strict repayment schedules that must be met. |
| Sale of assets | Disposing of unused items to generate immediate cash. | May fetch low prices, and assets could be needed for future growth. |
| Sale and leaseback | Selling an asset but renting it back to continue using it. | Leads to ongoing lease payments and loss of any future increase in asset value. |
| Managing trade receivables | Strategies like limiting credit periods, demanding quicker payments, selling debts to factoring companies, checking new customers' credit history via agencies or references, or providing discounts for early settlement. | Discounts reduce overall profit margins, and stricter terms might deter customers. |
Methods to reduce cash outflows
Reducing outflows helps preserve existing cash by delaying or minimising payments.
| Method | Description | Drawbacks |
|---|---|---|
| Delaying capital expenditure | Putting off buying new equipment or machinery to avoid large upfront costs. | Can lead to lower efficiency and restrict the business's ability to expand. |
| Leasing instead of buying | Renting equipment rather than purchasing it outright to spread costs over time. | The business does not own the asset, and interest is added to the lease payments. |
| Cutting non-essential overheads | Reducing spending on items not directly linked to production, such as office supplies or marketing. | Might harm future sales if cuts affect key areas like advertising. |
| Managing trade payables | Buying more on credit instead of cash, or negotiating longer payment times with suppliers. | Suppliers may offer worse service or refuse to supply, and cash discounts could be lost. |
How were these notes?