Cash flow essay

In this task, will analyses the cash flow problems a company may face and consider how such problems arise, making reference to the cash flow forecast. Definition of cash flow management A cash flow forecast can help to identify where there are potential shortfalls but might also indicate where there are large amounts of cash left at the end of a month or year. It needs to be noted however, that cash flow forecasts are just that, a forecast, and therefore the actual cash flow of the business should be monitored alongside the forecast to see if inflows and outflows are as expected, better or worse.

Problems within the cash flow forecast Problems occur with cash flows when the business’s outflows are greater than the opening balance plus the inflows, as this will result in a negative closing balance. This means that the business will not have enough cash to meet payments that are due. Very few businesses have consistent cash flows throughout the year; they are likely to experience busy times and quiet times. These fluctuations are known as the cash flow cycle. For some businesses, particularly those in a seasonal industry, these fluctuations can be quite severe.

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Someone who owns a small bed and breakfast in a seaside town will have to pay costs like rent, heat and light, insurance and bank charges throughout the year. In season, they will also additional costs like wages and stock, but it might only be in these summer months where there are any cash inflows. Causes of cash flow problems There are various causes of cash flow problems that companies need to be aware of such as the following; Seasonal demand The demand for some products and services is seasonal, and companies will incur costs in producing in advance of the peak season for sales.

This will cause a temporary, but predictable it is easy to persuade suppliers to provide credit or to negotiate a bank overdraft. Overriding Firms may become too confident and build up high levels of production and or stock, in anticipation of higher sales but without obtaining funding to support this. Over-investment in fixed assets Firms may invest in fixed assets in order to grow, but leave themselves with inadequate cash for day to day payments.

Credit sales The marketing department will want to give credit to customers, to encourage them to buy, but it can lead to a lack of cash in the organization if sales are to leading to immediate receipts of cash. Poor stock management Organizations might hold excessive stock levels, using up cash that could have been used for other purposes. Unforeseen change Cash flow difficulties might arise also from internal changes or external factors. These could be attributed to management errors or poor planning.

Types of cash flow problems There are also various types of cash flow problems that businesses need to be aware of such as the follows; Long term structural problems that will reduce profit in the foreseeable future, the lack of profit is causing shortage f cash that will continue to be a problem. Cyclical features such as seasonal demand that will always create cash shortages at given predictable times. Internal problems or inefficiencies that are reducing the firm’s cash flow. External changes that are affecting sales and or costs. Working capital problems.

Solutions to cash flow problems If a business has predicted cash flow problems in advance, then there are a number of possible solutions. These include; Over drafting arrangements A business with a fluctuating cash flow cycle should be able to show the recast to the bank and make arrangements for periods of negative cash flows. Bank sometimes offer free overdraft facilities to help businesses through these periods, but only if pre-agreed. Going overdrawn on a bank account without an agreement with the bank can be a very expensive option.

Negotiating terms with creditors Creditors are people of businesses that a business owes money to, normally because goods or services have been bought on credit as opposed to cash purchases. A business with cash flow problems could try to negotiate a longer payment term with its suppliers. A negative effect of this however may be the loss of any discounts offered for prompt or early payment. Reviewing and rescheduling capital expenditure Having identified cash flow problems, the owner or manager could review what cash outflows were being spent on.

Such a review might identify areas of expenditure that could be cut or postponed. It is difficult to do this if the expenditure is on revenue items. A business could for example postpone plans to replace machinery or buy a new van. Planning Improved planning and more through market research and intelligence will elf to anticipate changes, so that the firm can anticipate potential problems before they occur. Diversifying Diversifying the product portfolio may help to create a range that sells throughout the year.

Decision making Improved decision making procedures, planning, monitoring and control will prevent inefficiencies. The firm must balance the desire to delegate more responsibility with the need for close control in order to create an environment in which the workforces productivity is maximized. Contingency fund A contingency fund should be set aside to allow the company to meet unexpected payments or cope with lost income. In industries subject to more rapid change, a higher contingency fund should be kept.

Sahara and Ryan’s cash flow forecast have attached Sahara and Ryan’s cash flow accounts for their first year. The cash flow account illustrates that they are making a loss in their first 6 months, which is evident by the negative figures. It is also evident from the cash flow forecast Sahara and Ryan have invested El 2,500 into the business and that they have also taken out a bank loan in the sum of EYE,OOH. This effectively means that they will repay El ,OOH each month, which will mean it will take approximately 80 months to repay the bank loan.

It is also important to note that interest will be accrued on the bank loan, which will also need to be repaid. It is advisable in this situation that the bank loan is repaid in larger sums than El ,OOH to keep the interest to a minimum, which will mean the company will save more money. Also if the company repay the loan by paying E,OOH – E,OOH a month the loan will be paid off quicker and the interest it will accrue will be lower. Another option would be to take this bank loan away completely.

It is also important that the company retain their customers, which will help the Company produce more profits as currently the company is making less profit by doing sales on credit. In order to retain customers it is advisable that the company introduce and promote incentives; such as gifts, discounts, special offers or prizes that can be won by entering into a competition. These tactics will prove to be very effective as it will attract more customers and will buy their loyalty. The company could also advertise sees frequently which will help to keep the costs for advertisement to a minimum.

Although it does need to be noted that when the company did pay for the additional advertising per quarter year it did increase the company profit, however, towards the end of the year the profit had decreased. It is evident from the cash flow forecast that in August, September and October, which could be because of seasonal demands i. E. School holidays. Hence, it is advisable that more money is spent on advertising in the months where the business is not making enough profit to increase profitability instead of advertising all year round, which only increases company expenditure and it does not always translate into profit.

Furthermore, the company could rent out fixtures and fittings instead of purchasing them outright. This would prevent the company incurring debt in the first few months and gain more profit as they will be keeping the company expenditure to a minimum. The company could also look into purchasing second hand fixtures and fittings, which will be cheaper than purchasing new machinery. Furthermore, cutting down wages and salaries of the staff could be another option which would enable the company to save money.

It is very important to spread the costs out and cut the costs. Although this would most likely cause problems for the employees in the long term it is financially beneficial to the company because currently the company is spending EYE on staff wages and salaries. It needs to be noted that these changes could be temporary and not permanent until the company becomes profitable. Moreover, the company could also minimize money spent on utility bills and reduce costs of heating and lighting for example the staff members could ensure they turn off the lights behind hem.

This will save the company money which can be invested into the company to make it more profitable. It needs to be noted that the company’s cash flow will not be identical each year or month. For example the company’s expenditure on purchasing machinery and fixtures and fittings will vary from one month to another and it is important that businesses are aware of this. There are fixed expenditures of a company too such as staff salaries and rent although this could also vary if for example there is a pay rise or more staff is hired.

The utility bills will also vary from month to month pending on the amount of light and heat used for example in the months of December and January it is more likely that the heating bills are higher than they are in the summer months. It is important that company’s appreciate this because their cash flow forecast will not be identical every year to the previous years. Conclusion This advice can help companies save money and consider where they can in particular have cut backs which will help them overcome problems in their cash flow forecast. The money that is saved then can be invested into the business to make it more profitable.