1. Unit 2: Managing a business
Finance
Causes of cash-flow problems
cash flow: the amounts of money flowing into and out of a business over a period
of time.
Firms may have shortages of cash for a variety of reasons:
• seasonal demand
• overtrading, arising from over-expansion
• over-investment in fixed assets
• credit sales
• poor stock management
• poor management of suppliers
• unforeseen change, e.g. a strike
• losses or low profits

2. Unit 2: Managing a business
Finance
Ways of improving cash-flow
problems (1)
There are many ways of improving cash flow. The method(s) chosen may vary
according to the cause of the cash-flow problem. The AQA specification identifies five
main ways of improving cash-flow problems. These are shown on this slide and the
next:
• Bank overdraft. An agreement whereby the holder of a current account in a
bank is allowed to withdraw more money than there is in the account.
• Short-term loan. This is a sum of money provided to a firm or an individual for
a specific, agreed purpose. Repayment of the loan will usually take place within 2
years.

3. Unit 2: Managing a business
Finance
Ways of improving cash-flow
problems (2)
• Factoring. When a factoring company (usually a bank) buys the right to collect
the money from sales to customers on credit terms.
• Sale of assets. This process can improve cash flow by converting an unwanted
asset
(e.g. property or machinery) into cash, which can then be used to ease the
problem.
• Sale and leaseback of assets. Assets that are owned by the firm are sold to
raise cash and then rented back so that the company can still use them for an
agreed period of time.
The benefits and problems of using each of these five methods of improving cash
flow are discussed after the next slide.

4. Unit 2: Managing a business
Finance
Ways of improving cash-flow
problems (3)
Some other ways of improving cash flow (not specified in the AQA specification) are
listed below:
• Careful cash management (e.g. setting aside a contingency fund for
emergencies).
• Effective debtor management — chasing up customers who have not paid on
time.
• Stock management — making sure that money is not tied up in excessively
high stock levels.
• Diversifying to create a range of products that sell throughout the year.
• Careful cash flow budgeting.

5. Unit 2: Managing a business
Finance
Benefits of a bank overdraft
• It is easy to arrange and, once agreed, tends only to need confirming on an
annual basis.
• It is very flexible, as the overdraft can be used to pay for whatever the business
requires at the time.
• Interest is only paid on the level of the overdraft that is actually used.

6. Unit 2: Managing a business
Finance
Problems of a bank overdraft
• Bank overdrafts are based on flexible interest rates, so it is difficult to budget
accurately — the bank may change its rate of interest.
• The rate of interest charged on an overdraft is usually higher than that charged
on a short-term bank loan.
• Agreements to provide an overdraft normally allow the bank to DEMAND
IMMEDIATE REPAYMENT.

7. Unit 2: Managing a business
Finance
Benefits of short-term loans
• Bank loans are usually at a fixed rate of interest. The interest and repayment
schedule is calculated at the time of the loan, so it easy for the business to know
whether it can afford to repay the loan and budget for repayment.
• The rate of interest charged on a bank loan is usually less than that charged on
an overdraft, so it can be a cheaper solution to a cash-flow problem.
• A bank loan may be set up for a long period of time, to help the firm.

8. Unit 2: Managing a business
Finance
Problems of short-term loans
• Interest is paid on the whole of the sum borrowed.
• The business will need to provide the bank with security (collateral).

9. Unit 2: Managing a business
Finance
Benefits of (debtor ) factoring
• Improved cash flow in the short term.
• Lower administration costs.
• Reduced risk of bad debts.
• Can encourage businesses to be cautious and careful with their provision of
credit, to ensure that all debts are factored.

10. Unit 2: Managing a business
Finance
Problems of (debt) factoring
• The main problem is the cost to the business, which will lose between 5% and
10% of its revenue.
• The factoring company will charge more for factoring than it would for a loan, as
there are administrative expenses involved in chasing up the debts.
• Customers may prefer to deal directly with the business that sold them the
product. An aggressive factoring company may upset certain customers, who will
blame the original seller of the product.

11. Unit 2: Managing a business
Finance
Benefits of sale of assets
• Selling assets can raise a considerable sum of money, particularly in the case of
a large asset such as a building.
• If a particular asset is no longer helping towards the business’s overall success,
sale of the asset will not only ease the cash-flow problem, but also enhance the
overall profitability of the business.

12. Unit 2: Managing a business
Finance
Problems of sale of assets
• Assets such as buildings and machinery may be very difficult to sell quickly. A
business trying to make a quick sale usually has to accept a much lower price
than its true value.
• It is a fundamental principle of business that a firm should not normally sell fixed
assets to improve liquidity, as the fixed assets enable it to produce the goods
and services that create its profit.

13. Unit 2: Managing a business
Finance
Benefits of sale and leaseback
• This will overcome a cash-flow problem by providing an immediate inflow of
cash, usually of quite a significant level.
• A firm can be more flexible, as new and more efficient assets can be leased.
• The ownership of fixed assets can lead to a number of costs, such as
maintenance. Sale and leaseback eliminates these costs.
• Owning an asset can distract a business from its core activity because it has to
get involved with activities such as property management or organising a
transport fleet.

14. Unit 2: Managing a business
Finance
Problems of sale and leaseback
• In the long term, the firm will usually pay more in rent than it receives from its
sale.
• As a result, sale and leaseback will also reduce the value of the firm’s assets that
can be used as security against future loans.
• The business may eventually lose the use of the asset when the lease ends, as a
competitor may be prepared to pay a higher rental for the lease.

15. Unit 2: Managing a business
Finance
Finding the causes of a cash-flow
problem: group exercise
Find three or four possible causes of the forecast cash-flow problems in the situation below.
* In quarters 2 and 3, customers will be given 6 months’ credit when they buy product A, to boost sales
2009 Qtr 1
(£000s)
2009 Qtr 2
(£000s)
2009 Qtr 3
(£000s)
2009 Qtr 4
(£000s)
Opening balance 0 19 16 (24)
Sales income: product A* 20 0 0 24
Sales income: product B 55 52 48 42
Total inflows 75 52 48 66
Raw material costs 22 22 20 17
Wages 34 33 42 40
Capital costs 0 0 26 0
Total outflows 56 55 88 57
Net cash flow 19 (3) (40) 9
Closing balance 19 16 (24) (15)

16. Unit 2: Managing a business
Finance
Finding the causes of a cash-flow
problem: answers (1)
Possible causes:
• credit given to customers of product A leading to 6 months’ delay in receiving
cash
• steadily declining sales of product B, bringing in less income
• significant increase in wage payments in quarter 3
• large expenditure on capital costs in quarter 3

17. Unit 2: Managing a business
Finance
Finding the causes of a cash-flow
problem: individual exercise
Find three or four possible causes of the cash-flow problem in the situation shown below.
2010 Qtr 1
(£000s)
2010 Qtr 2
(£000s)
2010 Qtr 3
(£000s)
2010 Qtr 4
(£000s)
Opening balance 0 25 10 (26)
Sales income (total inflows) 85 75 40 95
Raw material costs 27 25 25 55
Wages 33 33 27 33
Capital costs 0 0 0 0
Vehicle purchase 0 32 0 0
Loan repayment 0 0 24 0
Total outflows 60 90 76 88
Net cash flow 25 (15) (36) 7
Closing balance 25 10 (26) (19)

18. Unit 2: Managing a business
Finance
Finding the causes of a cash-flow
problem: answers (2)
Possible causes:
• seasonal sales — dramatic fall of income in quarter 3
• purchase of £32,000 vehicle in quarter 2
• repayment of loan — £24,000 in quarter 3
• large increase in raw material costs in quarter 4 has prevented recovery

19. Unit 2: Managing a business
Finance
Solving cash-flow problems (1)
In groups, discuss:
• possible solutions to the cash-flow problems listed on the slide ‘Finding
the causes of a cash-flow problem: group exercise’
• possible solutions to the cash-flow problems listed on the slide ‘Finding
the causes of a cash-flow problem: individual exercise’

20. Unit 2: Managing a business
Finance
Solving cash-flow problems (2)
Possible answer to problems (group exercise)
Problem Possible solution
Credit given to customers of product A Debt factoring
Declining sales of product B Change marketing
Increase in wages Investigate reason
Capital costs Lease asset

21. Unit 2: Managing a business
Finance
Solving cash-flow problems (3)
Possible answer to problems (individual exercise)
Problem Possible solution
Seasonal demand Broaden product range
Purchase of asset Lease asset
Repayment of loan Spread repayment over time
Raw material costs Research other suppliers