1. Improving Cash Flow

2. Key issues for this topic
What is a cash flow problem?
Why do cash flow problems occur?
How a business can improve its cash flow to avoid or address problems

3. Starter Activity
Spend Five Minutes…..
Listing as many methods of Cash Inflow into a Business
Listing as many methods of Cash Outflow into a Business
After five minutes – Share our Ideas!

4. Cash Inflows and Outflows
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

5. Why Do Businesses Need Cash?
Finance is needed for…
?????
Think of the three main
Requirements and uses of cash in a business!

6. Why Businesses Need Cash
Finance is needed for…
Business Set-up
Day-to-day trading (working capital)
Growth

7. A Typical Cash Flow Cycle
Stocks ordered from supplier
Inflow – cash paid by customers
Production turns stocks into products
Customers pay for their purchases
Outflow - cash paid to suppliers & employees
Stocks held until a customer is found
Products sold to customers

8. The Cash Flow Operating Cycle
It is equal to:
The time that goods are in stock
plus the time that debtors take to pay
minus the period of credit received from suppliers
The working capital cycle can be shortened by
reducing the level of stock - this lowers the number of days the stock is held
speeding up the rate of debtor collection -the faster business collects from its debtors the better
The shorter the cycle, the lower the value of working capital to be financed by other sources

9. What is cash flow problem?
When a business does not have enough cash to be able to pay its liabilities

10. Main Causes of Cash Flow Problems
Low profits or (worse) losses
Over-investment in capacity
Too much stock
Allowing customers too much credit
Overtrading
Unexpected changes
Seasonal demand

11. Profit = most important source of cash
The profit a business makes from trading is the most important source of cash
There is a direct link between low profits or losses and cash flow problems
Most loss-making businesses eventually run out of cash

12. Over-investment in capacity
Spending too much on fixed assets
Made worse if short-term finance is used (e.g. bank overdraft)
Fixed assets are hard to turn back into cash

13. Too much stock? Excess stocks tie up cash
Increased risk that stocks become obsolete
But...
There needs to be enough stock to meet demand
Bulk buying may mean lower purchase prices

14. Allowing Customers Too Much Credit
Customers who buy on credit are called “trade debtors”
Offer credit = good way of building sales
But...
Late payment is a common problem
Worse still, the debt may go “bad”

15. Overtrading (1)
Where a business expands too quickly, putting pressure on short-term finance
Classic example – retail chains
Keen to open new outlets
Have to pay rent in advance, pay for shop-fitting, pay for stocks
Large outlay before sales begin in new store
Businesses that rely on long-term contracts also at high risk of overtrading

16. Overtrading (2)
Cause
Business expands its order book at a faster rate than access to working capital will sustain
Symptoms
Higher trade debtor figure
Cash running out
Withholding payments to suppliers
Actions
Reduce business activity – slow growth down
Introduce new share capital to ease the strain
Improve the management of working capital

17. Unexpected changes
Events that are not included in the cash flow forecast
Internal change
E.g. Machinery breakdown, loss of key staff
External change
E.g. Economic downturn, accidents

18. Seasonal demand
Where there are predictable changes in demand & cash flow
Production or purchasing usually in advance of seasonal peak in demand = cash outflows before inflows
This can be managed – cash flow forecast should allow for seasonal changes

19. Handling Cash Flow Problems

20. How to Handle Cash Flow Problems
Have a good cash flow forecast
Manage working capital effectively
Choose the right sources of finance
Bank overdraft v bank loan
Factoring
Sale and leaseback

21. Importance of Good Cash Flow Forecasts
The key to cash flow management is having good information
A good cash flow forecast:
Updated regularly
Makes sensible assumptions
Allows for unexpected changes

22. Managing Working Capital
Focus on
Stocks
Debtors
Creditors

23. Improving working capital
Debtors
Amounts owed by customers
Creditors
Amounts owed to suppliers
Stocks
Cash tied up in stocks

24. What is working capital?
Working capital is the cash needed to pay for the day to day trading of the business
Often, suppliers and employees have to be paid before customer pay for their goods

25. Why working capital is important
Working capital “oils the wheels” of business
Businesses use cash to finance stocks through the production process
It facilitates the smooth flow of production and the supply of goods to customers
In financing debtors, it enables the business to offer credit to customers

26. Working capital needed depends on
Planned production volumes
Forecast cost per unit
The length of the production cycle
Credit terms allowed to customers
Credit terms received from suppliers

27. A lack of working capital means…
Harder to buy in bulk and benefit from discounts
Difficulties in offering credit to customer with the danger of losing sales
Loss of reputation with suppliers if there are difficulties in settling debts
Harder to respond to opportunities
Increased danger of overtrading

28. Dealing with working capital shortages
Discount prices
Reduce purchases
Negotiate more credit from suppliers
Delay the payment of bills (but not for too long)
Credit control - chase trade debtors (customers who haven’t paid)
Negotiate a bank overdraft
Debt factoring
Sell assets
Sale and leaseback

29. Managing debtors better
Credit control
Policies on how much credit to give and repayment terms and conditions
Measures to control doubtful debtors
Credit checking
Selling off debts to debt factors
Cash discounts for prompt payment
Improved record keeping – e.g. accurate and timely invoicing

30. Debt factoring
The selling of debtors (money owned to the business) to a third party
This generates cash
It guarantees the firm a percentage of money owed to it
But will reduce income and profit margin made on sales
Cost involved in factoring can be high

31. What is credit control? Establishing credit limits for new customers
Credit checking new and existing customers
Setting realistic credit limits
Monitoring the age of debts and chasing up bad debts
Determine appropriate terms and conditions for credit
Chasing up debtors will get payment in sooner but may upset customers

32. Trade creditors
Amounts owed to suppliers for goods supplied on credit and not yet paid for
Delayed payment means that the firm retains cash longer
Have to be careful not to damage firm’s credit reputation and rating
Trade creditors are seen (wrongly) as a “free” source of capital
Some firms habitually delay payment to creditors in order to enhance their cash flow - a short sighted policy and raises ethical issues

33. Managing Stocks
Stock refers to goods purchased and awaiting use or produced and awaiting sale
Stocks take the form of raw materials, work-in-progress and finished goods
Stockholding is costly and therefore it is sound business to:
keep smaller balances (just in time stocks)
computerise ordering to improve efficiency
improve stock control
This will cut down the spending on stock but may leave the firm vulnerable to stock out

34. Cash management
Always necessary to hold some cash for transactions, precautionary reasons and for speculative purposes (awaiting a business opportunity)
Cash management involves the construction of a cash budget
Cash flows should be monitored
Excess cash should be profitably invested
Provision of overdraft facilities should be negotiated in case of cash shortage

35. Improving the cash position
Short term
Reduce current assets (stock and debtors)
Increase current liabilities (delaying payment)
Sell surplus fixed assets
Long term
Increase equity finance
Increase long term liabilities
Reduce net outflow on fixed assets

36. Should selling prices be discounted?
Price discounting is designed to improve the cash flow into the business
It generates cash through increased sales
Also reduces stock levels
But
It may undermine the firm’s pricing structure
It may leave the firm with low stocks
Its success does depend on price elasticity of demand

37. Bank overdraft v Bank loan
Banks are the traditional “port of call” for businesses with cash flow problems
However, the Credit Crunch has made banks much more wary of lending to troubled businesses
Assuming this finance is available, which one should a business go for?

38. Bank overdraft v 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

39. Sale of assets
Selling spare or surplus assets is a way to achieve a short-term boost to cash flow
Good examples: spare land, surplus equipment
Note – not all businesses have spare assets

40. Sale and Leaseback Specialist method of raising cash
Involves selling fixed assets and then leasing them back from new owner
Tends to involve business properties (e.g. Hotels, supermarkets, offices – popular when property market was booming
Note: can only be done once!

41. Test Your Understanding

42. Improving Cash Flow