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Improving Cash Flow

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Improving Cash Flow

  1. 1. Improving Cash Flow
  2. 2. Key issues to consider <ul><li>How does cash flow in a business? </li></ul><ul><li>Why do cash flow problems occur? </li></ul><ul><li>How a business can improve its cash flow to avoid or address problems </li></ul>
  3. 3. Remember where cash comes from…and where it goes to Cash inflows Cash outflows Cash sales Payments to suppliers Receipts from trade debtors Wages and salaries Sale of fixed assets Payments for fixed assets Interest on bank balances Tax on profits Grants Interest on loans & overdrafts Loans from bank Dividends paid to shareholders Share capital invested Repayment of loans
  4. 4. Cash “flows” around a business Stocks ordered from supplier Production turns stocks into products Products sold to customers Customers pay for their purchases Stocks held until a customer is found Outflow - cash paid to suppliers & employees Inflow – cash paid by customers
  5. 5. What is cash flow problem? When a business does not have enough cash to be able to pay its liabilities
  6. 6. Main causes of cash flow problems <ul><li>Low profits or (worse) losses </li></ul><ul><li>Too much production capacity </li></ul><ul><li>Too much stock </li></ul><ul><li>Allowing customers too much credit </li></ul><ul><li>Overtrading – growing too fast </li></ul><ul><li>Unexpected changes in the business </li></ul><ul><li>Seasonal demand </li></ul>
  7. 7. Profit = most important source of cash <ul><li>The profit a business makes from trading is the most important source of cash </li></ul><ul><li>There is a direct link between low profits or losses and cash flow problems </li></ul><ul><li>Most loss-making businesses eventually run out of cash </li></ul>
  8. 8. Too much spending on capacity <ul><li>Spending too much on fixed assets </li></ul><ul><li>Made worse if short-term finance is used (e.g. bank overdraft) </li></ul><ul><li>Fixed assets are hard to turn back into cash in the short-term </li></ul>
  9. 9. Too much stock? <ul><li>Excess stocks tie up cash </li></ul><ul><li>Increased risk that stocks become obsolete </li></ul><ul><li>But... </li></ul><ul><li>There needs to be enough stock to meet demand </li></ul><ul><li>Bulk buying may mean lower purchase prices </li></ul>
  10. 10. Allowing customers too much credit <ul><li>Customers who buy on credit are called “ trade debtors ” </li></ul><ul><li>Offer credit = good way of building sales </li></ul><ul><li>But... </li></ul><ul><li>Late payment is a common problem </li></ul><ul><li>Worse still, the debt may go “bad” </li></ul>
  11. 11. Overtrading (1) <ul><li>Where a business expands too quickly, putting pressure on short-term finance </li></ul><ul><li>Classic example – retail chains </li></ul><ul><ul><li>Keen to open new outlets </li></ul></ul><ul><ul><li>Have to pay rent in advance, pay for shop-fitting, pay for stocks </li></ul></ul><ul><ul><li>Large outlay before sales begin in new store </li></ul></ul><ul><li>Businesses that rely on long-term contracts also at high risk of overtrading </li></ul>
  12. 12. Overtrading (2) Cause Business expands its order book at a faster rate than access to working capital will sustain Symptoms Higher amounts owed by customers Cash running out Having to delay payments to suppliers Actions Reduce business activity – slow growth down Introduce new share capital to ease the strain Improve the management of working capital – e.g. reduce stocks
  13. 13. Unexpected changes <ul><li>Events that are not included in the cash flow forecast </li></ul><ul><li>Internal change </li></ul><ul><ul><li>E.g. machinery breakdown, loss of key staff </li></ul></ul><ul><li>External change </li></ul><ul><ul><li>E.g. Economic downturn, accidents </li></ul></ul>
  14. 14. Seasonal demand <ul><li>Where there are predictable changes in demand & cash flow </li></ul><ul><li>Production or purchasing usually in advance of seasonal peak in demand = cash outflows before inflows </li></ul><ul><li>This can be managed – cash flow forecast should allow for seasonal changes </li></ul>
  15. 15. Handling Cash Flow Problems
  16. 16. How to handle cash flow problems <ul><li>Have a good cash flow forecast </li></ul><ul><li>Manage working capital effectively </li></ul><ul><li>Choose the right sources of finance </li></ul><ul><ul><li>Bank overdraft v bank loan </li></ul></ul><ul><ul><li>Factoring </li></ul></ul><ul><ul><li>Sale and leaseback </li></ul></ul>
  17. 17. Cash flow forecasting is SO important <ul><li>The key to cash flow management is having good information </li></ul><ul><li>A good cash flow forecast: </li></ul><ul><ul><li>Updated regularly </li></ul></ul><ul><ul><li>Makes sensible assumptions </li></ul></ul><ul><ul><li>Allows for unexpected changes </li></ul></ul>
  18. 18. Managing working capital Stocks Debtors Creditors Focus on
  19. 19. Improving working capital Debtors Amounts owed by customers Creditors Amounts owed to suppliers Stocks Cash tied up in stocks
  20. 20. Managing debtors better <ul><li>Credit control </li></ul><ul><ul><li>Policies on how much credit to give and repayment terms and conditions </li></ul></ul><ul><ul><li>Measures to control doubtful debtors </li></ul></ul><ul><ul><li>Credit checking </li></ul></ul><ul><li>Selling off debts to debt factors </li></ul><ul><li>Cash discounts for prompt payment </li></ul><ul><li>Improved record keeping – e.g. accurate and timely invoicing </li></ul>
  21. 21. Debt factoring <ul><li>The selling of debtors (money owned to the business) to a third party </li></ul><ul><li>This generates cash </li></ul><ul><li>It guarantees the firm a percentage of money owed to it </li></ul><ul><li>But will reduce income and profit margin made on sales </li></ul><ul><li>Cost involved in factoring can be high </li></ul>
  22. 22. What is credit control? <ul><li>Establishing credit limits for new customers </li></ul><ul><li>Credit checking new and existing customers </li></ul><ul><li>Setting realistic credit limits </li></ul><ul><li>Monitoring the age of debts and chasing up bad debts </li></ul><ul><li>Determine appropriate terms and conditions for credit </li></ul><ul><li>Chasing up debtors will get payment in sooner but may upset customers </li></ul>
  23. 23. Trade creditors <ul><li>Amounts owed to suppliers for goods supplied on credit and not yet paid for </li></ul><ul><li>Delayed payment means that the firm retains cash longer </li></ul><ul><li>Have to be careful not to damage firm’s credit reputation and rating </li></ul><ul><li>Trade creditors are seen (wrongly) as a “free” source of capital </li></ul><ul><li>Some firms habitually delay payment to creditors in order to enhance their cash flow - a short sighted policy and raises ethical issues </li></ul>
  24. 24. Managing Stocks <ul><li>Stock refers to goods purchased and awaiting use or produced and awaiting sale </li></ul><ul><li>Stocks take the form of raw materials, work-in-progress and finished goods </li></ul><ul><li>Stockholding is costly and therefore it is sound business to: </li></ul><ul><ul><li>keep smaller balances (just in time stocks) </li></ul></ul><ul><ul><li>computerise ordering to improve efficiency </li></ul></ul><ul><ul><li>improve stock control </li></ul></ul><ul><li>This will cut down the spending on stock but may leave the firm vulnerable to stock out </li></ul>
  25. 25. Cash management <ul><li>Always necessary to hold some cash for transactions, precautionary reasons and for speculative purposes (awaiting a business opportunity) </li></ul><ul><li>Cash management involves the construction of a cash budget </li></ul><ul><li>Cash flows should be monitored </li></ul><ul><li>Excess cash should be profitably invested </li></ul><ul><li>Provision of overdraft facilities should be negotiated in case of cash shortage </li></ul>
  26. 26. Improving the cash position <ul><li>Short term </li></ul><ul><ul><li>Reduce current assets (stock and debtors) </li></ul></ul><ul><ul><li>Increase current liabilities (delaying payment) </li></ul></ul><ul><ul><li>Sell surplus fixed assets </li></ul></ul><ul><li>Long term </li></ul><ul><ul><li>Increase equity finance </li></ul></ul><ul><ul><li>Increase long term liabilities </li></ul></ul><ul><ul><li>Reduce net outflow on fixed assets </li></ul></ul>
  27. 27. Should selling prices be discounted? <ul><li>Price discounting is designed to improve the cash flow into the business </li></ul><ul><li>It generates cash through increased sales </li></ul><ul><li>Also reduces stock levels </li></ul><ul><li>But </li></ul><ul><li>It may undermine the firm’s pricing structure </li></ul><ul><li>It may leave the firm with low stocks </li></ul><ul><li>Its success does depend on price elasticity of demand </li></ul>
  28. 28. Bank overdraft v Bank loan <ul><li>Banks are the traditional “port of call” for businesses with cash flow problems </li></ul><ul><li>However, the Credit Crunch made banks much more wary of lending to troubled businesses </li></ul><ul><li>Assuming this finance is available, which one should a business go for? </li></ul>
  29. 29. Bank overdraft v Bank loan Bank Overdraft Bank Loan Advantages Relatively easy to arrange Greater certainty of funding, provided terms of loan complied with Flexible – use as cash flow requires Lower interest rate than a bank overdraft Interest – only paid on the amount borrowed under the facility Appropriate method of financing fixed assets Not secured on assets of business Disadvantages Can be withdrawn at short notice Requires security (collateral) Interest charge varies with changes in interest rate Interest paid on full amount outstanding Higher interest rate than a bank loan Harder to arrange
  30. 30. Sale of assets <ul><li>Selling spare or surplus assets is a way to achieve a short-term boost to cash flow </li></ul><ul><li>Good examples: spare land, surplus equipment </li></ul><ul><li>Note – not all businesses have spare assets </li></ul>
  31. 31. Sale and Leaseback <ul><li>Specialist method of raising cash </li></ul><ul><li>Involves selling fixed assets and then leasing them back from new owner </li></ul><ul><li>Tends to involve business properties (e.g. Hotels, supermarkets, offices – popular when property market was booming </li></ul><ul><li>Note: can only be done once! </li></ul>
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