Improving Cash Flow

Question 1

Credit control

Answer 1

The monitoring of debts to ensure that credit periods are not exceeded.

Question 2

Bad debt

Answer 2

Unpaid customer bills that are now very unlikely to ever be paid.

Question 3

Over trading

Answer 3

Expanding a business rapidly without obtaining all of the necessary finance so that a cash flow shortage develops.

Question 4

Creditors

Answer 4

Suppliers owed money by the business - purchases have been made on credit.

Question 5

Causes of cash flow problems:

Answer 5

• LACK OF PLANNING. e.g lack of cash flow forecasting can make cash flow problems more likely.
• POOR CREDIT CONTROL. Is this checking is inefficient and badly managed then debtors will not be ‘chased up’ for payment and potential bad debts will not be identified.
• ALLOWING CUSTOMERS TOO LONG TO PAY DEBTS. Many businesses have to offer trade credit to be competitive. This can mean short term cash inflows are reduced which could lead to cash flow difficulties.
• OVERTRADING. When a business expands rapidly and has to pay for the expansion and for increased wages and materials months before it received cash from additional sales.
• UNEXPECTED EVENTS. Cash flow forecast never 100% guaranteed accurate. E.g break down of a delivery can that needs to be replaced, or a dip in predicted sales income, or a competitor lowers prices unexpectedly - could lead to negative met monthly cash flows.

Question 6

Ways to improve cash flow:

Answer 6

• INCREASE CASH INFLOWS
• REDUCE CASH OUTFLOWS

Read page 121 & 122 for methods of doing this.

Question 7

Overdraft

Answer 7

Arranging a flexible loan on which the business can draw as necessary up to an agreed limit.

Drawbacks:

• High rates of interest. There may be an overdraft arrangement fee.
• Can be withdrawn by the bank and this often causes insolvency.

Question 8

Short-term loan

Answer 8

Fixed amount borrowed for agreed length of time.
Drawbacks:
- interest costs
- must be repaid by the due date

Question 9

Reduce credit terms to customers

Answer 9

Cash flow will be bought forward by reducing credit terms from, say two months to one month.

Drawbacks:
- customers may purchase products from firms that offer extended credit terms.

Question 10

Sale and leaseback

Answer 10

Selling an asset, e.g. To a finance company, but continuing to use the asset. An annual leasing charge is paid to the new owner.

Drawbacks:

• leasing costs add to annual overheads.
• Loss of potential profit of the asset rises in price.
• The assets could have been used as collateral for future loans.

Question 11

Debt factoring

Answer 11

Debt factoring companies buy the customer bills from a business and offer immediate cash. This reduces risk of bad debts too.

Drawbacks:

• only about 90-95% of the debt will now be paid by the debt factoring company - reducing profit.
• the customer has the debt collected by the finance company - does this suggest that your business in trouble?

Question 12

Reducing cash outflow methods:

Answer 12

• Delay payments to suppliers.
• Delay spending on capital equipments
• Use leading not outright purchase of capital equipment.
• Cut overhead spending that does not directly affect output, e.g. Promotion costs.