Many businesses go into liquidation and close down because of the lack of sufficient cash to meet commitments, not because of lack of profits. It is therefore vital that a business keeps a record of its cash flows and uses it to monitor and control inflows and outflows of money.
Cash comes in from:
*profits
*sale of fixed assets
*sale of stock
*decreases in debtors
*capital introduced
*loans receivedincreases in creditors
and out from:
*losses
*purchase of fixed assets
*purchase of stock
*increases in debtors
*drawings or dividends paid
*loans repaid
*decreases in creditors
Therefore managers must be aware of why the business can end up with no money to pay off debts.
REASONS FOR CASH FLOW PROBLEMS
*Could be higher wages (ie more staff)
*poor credit terms with suppliers and customers
*too much stock lying in storage and not being sold
*seasonal differences with regards to sales (drinks firms sell more in summer; think of tourist *resorts; gas and electrical firms make more profits during the winter)
*rise in expenses and overheads (even fuel prices can affect EVERYTHING!!!)
SOLVING CASH FLOW PROBLEMS
*business can arrange loans for the periods when they have negative cash flow
*they can raise prices on goods they sell to raise revenue
*they can change credit terms with suppliers (trying to get longer to pay off their purchases)
*or try and negotiate better discounts
*or they can change credit terms for customers by making them shorter
*they can also cut overheads and expenses
*introduce Just-in-time (or lean production) stock methods
*hold off on buying new machinery and equipment
*and can make redundancies (labour is one of the highest expenses)
TIP:
When you identify and give a reason, make sure they are compatible and make sense. ie don't identify having high wages as a problem and then say you will solve that by changing credit terms! (Believe me I have seen it happen!).
