BUSINESS STUDIES UNIT 2: IMPROVING CASH FLOW

Content:

Even when high set up costs have been completed, new businesses can be shocked by the capital needed to run the business day by day. To operate the business needs money to buy stock, pay wages, etc. And if these aren’t paid on time there can be serious consequences...

Analysis:

Managing these finances is a continuous process and when you start a business it takes time to generate income. To do this you need to use the costs from the capital invested into the business. As the business cycle gets going, income from customers will be available to pay for expenditure, so they will need to generate enough cash to meet daily requirements.

Application:

Each business will have its own distinct cycle. But they can suffer unexpected shocks which they have to use the cash that they get for. But a rough cycle would be:

Capital invested – sell to customers on trade credit – customers pay up – buy materials – produce goods – then back to the beginning again. 

• With suppliers - with too little cash it will mean you are unable to pay back suppliers and will resort to a delay in payment and then you may be refused credit on future orders. 
• Banks are quick to sense a cash flow crisis - and the bank may prevent you from getting an overdraft because of this, they may also insist you pay back within 24 hours which can put your business in a terrible situation.
• Opportunities may be missed - the business may not be able to buy in bulk anymore and this will remove the advantage of lower prices and it could have to refuse a large order because it cant finance the equipment needed for it.

Content:

Good management of cash flows start with good forecasting...

Analysis:

Cash flow forecasts are able to predict any cash shortfalls. This will let the business take steps so that they can avoid any problems with their cash flow in the future. It is helpful to have a generous overdraft limit which can be drawn upon when needed. This can act as a safety net for the business. It also involves improving the cash position at all times.

Application:

A firm can speed up the cash inflows into the business from, debtors so they are able to have more cash coming into the business when they really need it and they may be able to delay or reduce the cash outflows if they need to.

• Getting goods to the market in the shortest time possible - the sooner the goods reach the customer the sooner payment is received. It should be as efficient as possible.
• Getting paid as quickly as possible - you would want to get paid cash on delivery. but most work on credit, even worse it is interest free, so the customer has little incentive to pay up quickly. Early payments should be encouraged. 
• Controlling debtors - confusingly this is known as credit control. If customers don't pay on time this will mean cash doesn't come into the business. They can stop this by ensuring the debtor is credit worthy before granting credit.
• Factoring - it can be possible to speed up payments by factoring the money owed to the business. The company can receive 80% of the amount within 24 hours after the invoice is received and then collect the rest of the money when the credit period is over. But this depends on the length of time before the payment is due, the credit rating of the creditor and current rates of interest.

• Obtaining maximum possible credit for purchases - delaying payment of bills will keep the cash in the business for longer. 
• Controlling costs - this can be done by keeping administrative and production costs to a minimum. Efficient production reduces costs. Savings may be possible by upgrading machinery to replace labour.
• Keeping stocks of raw materials to a minimum - good stock management, such as in a Just In Time system means that the business is not paying for stocks before it needs them for production. Controlling stock losses means that less is spent on replacements for lost or damaged stock.

Content:

Cash flow can also be improved by keeping cash in the business...

Analysis:

Minimising short term spending on new equipment keeps cash in the business.

Application:

They can:

• Lease rather than buy equipment - this increases expenses but conserves capital.
• Renting rather than buying - this also allows capital to remain in the business
• Postponing expenditure - For example; new company cars

• Using an overdraft - an overdraft is arranged with a bank. It allows the business to overdraw up to an agreed limit negotiated in advance. They can usually incur interest rates as high as 6% over base rate. It is suitable for small or short term shortages of cash.
• Taking out a short term loan - this incurs a lower rate of interest than an overdraft, but it is less flexible than an overdraft because it offers more security and may have a fixed interest charge.
• Sale and Leaseback of Assets - if a business has fixed assets it may be possible to negotiate a sale and leaseback arrangement. This will release capital and give an immediate inflow of cash. This will become a regular and ongoing cost that would need to be budgeted.

Bad debts - payments that are long overdue and cannot be expected to be received.

Credit period - the length of time allowed for payment

Factoring - obtaining part payment from a factoring company of the amount owwed. The factoring company will then collect the debt and pass over the balance of the payment.

Sale and Leaseback - a contract that, at the same time, sells the freehold to a piece of property and buys back the leasehold.