4. Managing cash flow

Managing cash flow
Problem - Insufficient
working capital
Low cash figure
Insufficient cash available to pay for supplies and other
day-to-day expenditures.
Possible cause - Overtrading (the business has lots of
orders and purchases supplies to meet them on credit.
However, cash form sales does not arrive quickly
enough to pay suppliers). This can lead to bankruptcy.
Possible solution - Inject new capital (long-term finance)
eg via a loan, or else slow the rate of growth.
Low debtors figure
Not usually a problem, but could indicate low
sales figures if credit offers to customers prove
Possible solution – Introduce attractive trade
credit terms to increase sales.
Low stock
Low raw material or component stock levels - may interrupt
the production process. Delays will add to costs.
Low stocks of finished products - delays in responding to
orders from customers. Also, potential sales are lost.
Possible causes - lack of cash or credit to purchase stock,
or deliberately reducing levels below an optimal point.
Solution – Improve efficiency of stock control system (eg
JIT) or purchase more stock.
High creditor figure
The business owes large sums to creditors who may refuse
to supply the business in future if they are not paid on time.
Banks may demand repayment of overdrafts, and firms
operating close to overdraft limits may not be able to cope
with additional unforeseen demands for cash.
Possible causes - Over-reliance on trade credit and shortterm financing eg overdrafts (which are repayable upon
Possible solution – Raise finance eg via a loan to pay debts
Problem - Excessive
working capital
High stock
Adds to costs (eg storage, insurance, depreciation due to
obsolescence etc).
Possible causes - over-stocking (allowing stock levels to build up),
eg following a downturn in demand a firm might fail to reduce
production levels, leading to higher stock levels.
Possible solutions - Allow stocks to be sold without replacing them
(running down stock). This will generate cash without increasing
High cash
There is an opportunity cost of holding excessive cash
– the money could be used elsewhere in the business
Possible solution - Excess cash can be released to
pay off long term debts, purchase fixed assets,
deposited in a high-interest savings account, or
returned to the owners of the business eg via a
dividend payment.
High debtors
Debtors may be taking longer to repay debts (results in
lost interest the business could be receiving).
Also, added costs of chasing up debtors.
Possible causes - Poor debt collection, or poor
screening of credit customers?
Possible solutions - Chase over-due payments and
begin credit checks.
Other causes
During a recession debtors may be late with payments
as they try to improve their own cash flow situations.
Seasonal demand. At times of peak demand firms
need to ensure they carry enough stock to meet the
needs of customers (eg toy manufacturers at
Christmas). They may have difficulty paying suppliers
earlier in the year due to low sales at time.
Cash flow imbalances
A business may have sufficient working capital on
paper, but it may consist mainly of stock or debtors.
The firm could therefore still have difficulty meeting its
short-term liabilities. In this case cash levels can be
increased by reducing stock & chasing up debtors.
Firms with high cash levels but low stock may
experience production problems.