Cashflow Management - Improving Cash Flow

Main causes of cash flow problems:

• Low profits or (worse) losses

• Too much production capacity

• Excess inventories held

• Allowing customers too much credit and too long to pay

• Overtrading- growing business too fast

• Seasonal demand

How to manage cash flow problems:

• Use reliable cash flow forecasting

• Keep costs under control

• Manage working capital effectively

• Choose the right sources of finance

Managing working capital:

Effective working capital management focuses on:

• Stocks

• Debtors

• Creditors

Managing stocks:

• Stocks take the form of raw materials, work-in-progress and finished goods

• Stockholding is costly and therefore it is sound business to:

  • Keep smaller balances (just in time stocks)

  • Computerise ordering to improve efficiency

  • Improve stock control (e.g. stock control chart)

• This will cut spending on stocks but could leave the business vulnerable to stock-out

Managing amounts owed by customers:

• Credit control:

  • Policies on how much credit to give and repayment terms and conditions

  • Measures to Control Doubtful Debtors

  • Credit checking

• Selling off debts to debt factors

• Cash discounts for prompt payment

• Improved record keeping- e.g. accurate and timely invoicing

Debt factoring:

• The selling of debtors (money owed to the business) to a third party

• This generates cash

• It guarantees the firm a percentage of money owed to it

• But will reduce income and profit margin made on sales

• The cost involved in factoring can be high

Managing cash paid to suppliers:

• Trade credit- amounts owed to supplier for goods supplied on credit and not yet paid for

• Delayed payment means that the firm retains cash longer

• Have to be careful not to damage the firm’s credit reputation and rating

• Trade creditors are seen (wrongly) as a ‘free’ source of capital

• Some firms habitually delay payment to creditors to enhance their cash flow- a short-sighted policy that raises ethical issues

Evaluation: Improving a poor cash position:

• Short term:

  • Cut costs

  • Reduce current assets (stock and debtors)

  • Increase current liabilities (delaying payment)

  • Sell surplus fixed assets

• Long term:

  • Increase equity finance

  • Increase long-term liabilities

  • Reduce net outflow on fixed assets