A document outlining the problems of using cash flow budgeting and some possible solutions

1. Unit 5 M1
Lewis Appleton Mr McColgan
Cash flow problems
One of the problemsisthatitactuallytakesa while tostart makinga profitwithinthe business;one
of the reasonsforthismay be because of the £3,000 drawingstakeneachmonth.It takes10 months
to getout of the negative balance whichisalongtime,howevertheyare thenmakingahighprofit
so it’spossible totake more drawingsorspendmore onthe business.If theywere totake only
£1,000 a monthforthe firstyearthenthe businesswillhave apositive balanceafteronly5months
whichishalf the time.
Advertisingappearstobe a problem;the reasonforthisisit isunpredictable.If the moneyspenton
advertisingwastoincrease to£1,000 theirsalesmaydouble but it’salsopossiblethatthere would
not be a cost efficientdifference,the same applieswhenreducingthe moneyspentonadvertising.If
doublingthe advertisingmoney,suppliesanddrawings,the businesswilltake 8monthsto have a
positive budget,andafterone yeartheywill be £30,000 positive balance,butthisisnotguaranteed
to happenthisway. Howeverthe problemwiththisisthatbytakingthe £36,000 yearlydrawings,for
the firstyear he isonlyprofiting£16,000 because he deposited£20,000 capital of hisownmoney
intothe businessatthe start.
The advertisingisafixedcostmeaningithasto be paidfora setamount;if theydidn’tpayit then
theywouldnot make as much moneyastheycould.The rent hasto be paidso thisisone of the
mostimportantfixedcosts;the businessneedstomake sure thattheypaythisoff each monthso
that theyare able tooperate.
Anotherproblemisthatthe original closingbalance isnegative,anditcontinuestogetworse.It
takesa while togetout of the negative andthere isone pointwhere theyhave almost£16,000 debt.
At thispointif somethingwastohappentothe businesssuchasbeingunable tokeepupwithcosts,
the debtwouldhave tobe paidoff by the owner.Anotherproblemisthatmanybig costswere made
injust the firstmonth, the £10,000 van may nothave actuallybeenneededforthe firstfew months,
it couldhave beenpurchasedafewmonthslateror a cheapervancouldhave beenpurchased.
Anotherproblemisthatthe salesare not guaranteedandinFebruaryhe spentmore on supplies
than he had receivedasincome fromthe salesforthe month.The change inadvertisingis
noticeable,althoughthe businessis £300 betteroff eachmonth,inJune and Julytheywere earning
£22,000 insaleswhereasafterthe advertisinghaddecreasedforafew monthstheywere earning
£22,000 whichmeanstheymayhave beenbetteroff payingthe extra£300 a month.

2. Unit 5 D1
Lewis Appleton Mr McColgan
Possible solutions
Solutionone
Firstof all,the businesscouldspendmore onadvertising;the reasonfordoingthisisthat there isa
visible difference whenthe costschanged.Inthe monthjustbefore andafterthe costof advertising
was reducedfrom£500 to £200 there were salestotalling£22,000 a month,the followingmonththe
saleswere only£18,000 and at the endof the year theymanagedtogo back up to £20,000.
Therefore itisvisiblethatthe £300 reductionhada £4,000 difference insales.Thereforeincreasing
the advertisingto£1,000 may allowthe businesstohave salesof £30,000. Althoughtheywill be
spendinganother£800 each monththeycouldmake another£10,000.
Advantages
The advantagesof doingthisare that theycan make 50% more than theyusually do,eventhoughit
isnot guaranteedithas alreadybeenseenthatthe advertisinghasalarge effectonthe salesand
therefore itisat leastworthtryingfora few months.Thisisalsogoodbecause theydonot have to
keepthe price of advertisingupandif itdoesnot workas well astheywant itto, the price can be
reducedagain.Evenif theymake a small lossbyadvertisingforthe higherprice the brandawareness
will be increasedandtherefore the advertisingcouldstill have the effectonsalesfora few months
aftertheyreduce the amountagain,thismeansthat theycouldstill make aprofit.
Disadvantages
The disadvantagesare thatalthoughitmay soundthat theyare goingto make another£10,000
profit,itdoesnotmeantheywill.A 50% increase insalesalsomeansa 50% increase inmoneyspent
on supplies,therefore if theyusuallyspend£12,000 onsuppliesbeforethe increase,theywill then
needtospendan extra£6,000 on supplies.£10,000 - £6,000 - £1,000 = £3,000. Therefore theyare
actuallyonlygoingto potentiallybe £3,000 betteroff eachmonth insteadof the £10,000. Another
disadvantage isthatthe resultsare not guaranteedandif the saleswere tonotchange thenthey
wouldbe £800 worse off eachmonth.
Solutiontwo
The secondsolutionisthatthe ownerof the businesscouldtake lessmoneyforthe drawings,if they
were totake only£2,000 eachmonthinsteadof £3,000 theywouldonlyhave towaituntil Julyto
have a positive balance,theywouldbe personallyearning£24,000 for the firstyear althoughitis
actually£4,000 aftertakingawaythe capital investedinthe business.Howeverthe businesswould
actuallyhave a £15,000 positive balance atthe endof the yearwhichmeanstheycan thenstart to
take more drawings,or putmore moneyback intothe businesssuchasadvertisingora new and
bettervancouldbe purchased.
Advantages
The advantagesof doingthisare that the businesswouldbe inapositive budgetmuchearlierand
therefore if anythingwastogowrong the debtto paywouldnotbe as high.There isalsothenmore

3. Unit 5 D1
Lewis Appleton Mr McColgan
potential tospendthe moneybackintothe businesssuchasincreasingthe advertisingwhichwould
increase the chance of makinga higherprofitandthiscouldactuallybe usedwiththe firstsolution.
The moneyleftovercan alsobe spenton gettingbettertransportsuchas a van that useslessfuel
and has cheaperinsurance asalthoughthere wouldbe ahighercostat first,the moneysavedinthe
longtermwouldadd upand keepsthe businessspendingless moneysomore income canbe
generated.
Disadvantages
The disadvantagesof doingthisare that the owneractuallyneedsthe moneyfortheirownpersonal
livingcostsandtherefore theywouldhave tospendlesspersonallytobe able todothis.Thismay
meanthat theyhave to spendlessonluxuriesthattheywouldlike doing.Anotherdisadvantage is
that by puttingthe moneybackintothe businesstheymaybe spendingmore thantheyactually
needto.It alsohas to be consideredthattheirownlivingcosts mayinclude rent,electricity,heating
and otherimportantthingsthatcannot be unpaid.Therefore itmaymeanthattheyare notactually
able to take lessmoneyastheyare onlytakingwhattheyrequire.