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Cashflow 3.7 (Problems (Strategies (Additional finance (Delay payments to…
Cashflow 3.7
Profit v cashflow
A profitable business can easily run out of cash / become bankrupt. This is because a profitable product doesn't always mean it has a good cashflow
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Thus, if the business makes a profit = contribution to cash inflows, but the cash outflow is greater, there will be a negative net cash flow resulting in 'not enough cash'
Problems
Strategies
Increase cash inflow
Sale of assets = assets could be required in future, sold at lower price if sold fast?
Sale and leaseback = Leasing adds to overheads, could be loss of profit if the assets increase in value
Debt factoring = the customer would think the business is in trouble, 90-95% of the debt is repaid - loss of profit
Additional finance
Delay payments to suppliers = can ask for cash on delivery or not supply at all if suspicious or repayment, may reduce discounts
Delay spending on capital equipment = Expansion is hard, inefficient business if outdated
Use leasing = The asset is not owned by the company, adds to annual overheads due to interest
Cut overheads that do not affect output = Future D may fall due to lack of promotion or effective promotion
Decrease cash outflow
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Reduce credit terms to customer = customers may purchase products from firms that offer extended credit terms
Increase in cash sales = Sale of inventories at a lower price will improve cash flow but worsen profit margin
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Lack of planning: The forecast is an essential plan in business planning. If not done correctly, future cash problems and others may not be apprehended
Poor credit control: The monitoring of debts to ensure credit periods are not exceeded. If not done correctly, debtors will not be chased after and potential 'bad debts' will not be identified
Allowing customers too much credit: When businesses offer 'trade credit' to customers in order to remain competitive. However, this can lead to customers taking too long to pay = shortage in cash inflows - affects the cashflow
e.g. 2 businesses selling the same products. One offers trade credit of 2 months whereas the other demands cash payments. The customer will choose the first supplier as it improves th cash flow
Unexpected events: A sudden increase in costs could lead to negative monthly cash flows (replacement for a broken down van...)
Rapid expansion: Firm has to pay for the expansion and increased wages and materials, months before receiving cash from additional sales - can cause a cash flow shortage and overtrading
Definitions
Chas inflow: Payments in cash received by a business from consumers, the bank etc.
Cash outflow: Payments in cash made by a business to suppliers, workers etc.
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Overtrading: Expanding a business rapidly without obtaining the necessary finance so a cash flow shortage occurs
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Working capital
Without sufficient working capital a firm will lack liquidity, however, if it is too high there will be an opportunity cost of too much capital tied up in stocks, debtors and cash where it could be invested elsewhere (fixed assets)
Current assets (stock, debtors, cash) - current liabilities (creditors, overdrafts)
Working capital cycle
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Businesses attempt to reduce the time period by selling assets, collecting revenue from customers quickly or paying bills slowly to optimize the cashflow
Forecasts
Benefits
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Demonstration of periods of negative cash flows plans can be put into place to provide additional finance
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The cash inflows and outflows will be forecasted in order to predict the cashflow at the end of the month or year.
Some cash inflows may be easier to predict (Owners capital, bank loan payments) and others difficult (debtors payment, customers cash purchase)
Some cash outflows may be easier to predict (lease payments, annual rent payments) and others difficult (labour costs (depend on hours), electricity... bills (depending on use))
Relation between investment, profit and cash outflow
Private sector investment (in a company, in developing a product, building a factory etc.) are expected to make a profit
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