Study Notes: Business Finance & Accounting

Why It Causes a Cash Flow Problem

Low profits or (worse) losses

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
Remember - most loss-making businesses eventually run out of cash

Over-investment in capacity

This happens when a business spends too much on fixed assets
Problem is made worse if short-term finance is used (e.g. bank overdraft)
Fixed assets are hard to turn back into cash in the short-run

Too much stock

Holding too much stock ties up cash
+ Increased risk that stocks become obsolete
On the other hand...
There needs to be enough stock to meet demand
Bulk buying may mean lower purchase prices

Allowing customers too much credit

Customers who buy on credit are called “trade debtors”
Offer credit = good way of building sales
On the other hand...
Late payment is a common problem – and slow-paying customers often put a strain on cash flow
Worse still, the debt may go “bad” – i.e. it is not paid at all

Overtrading

Occurs 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 are also at high risk of overtrading

Unexpected changes

These are items or events that are not included in the cash flow forecast – they are unforeseen.  Examples include:

• Internal change (e.g. machinery breakdown, loss of key staff)
• External change (e.g. economic downturn, accidents, change in legislation that requires a business to invest in new facilities)

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