A cash flow problem arises when a business struggles to pay its debts as they become due.
Note that a cash flow problem is not necessarily the same as experiencing a cash outflow. A business often experiences a net cash outflow, for example when making a large payment for raw materials, new equipment or where there is a seasonal drop in demand.
However, when cash flow is consistently negative and the business uses up its cash balances, then the problem becomes serious.
The main causes of cash flow problems are:
Low profits or (worse) losses
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 production capacity. Factory equipment which is not being used does not generate revenues – so is often a waste of cash
Too much stock
Holding too much stock ties up cash and there is an increased risk that stocks become obsolete (i.e. it can't be sold)
Allowing customers too much credit
Customers who buy on credit are called "trade debtors" Offering credit to customers is a good way to build revenue, but late payment is a common problem and slow-paying customers put a strain on cash flow
Overtrading (growing too fast)
This occurs where a business expands too quickly, putting pressure on short-term finance. For example, a retail chain might try to open too many stores too quickly before each starts to generate profits
Predictable changes in seasonal demand create cash flow problems – but because they are expected, a business should be able to handle them
tutor2u's acclaimed Worked Answers series provide detailed guidance on how students could have achieved top grades in recent AQA and Edexcel GCSE Business Studies exams.