WorldExecutivesDigest| There are a variety of reasons why a business will suffer from a poor or weak cash flow and perhaps find itself in a position where its liquidity position is poor or weak. Perhaps the most important reason or cause of a cash flow problem is poor profitability or a business incurring losses. Other reasons which could also happen at the same time are the business has invested in too much capacity and has over expanded. Also, it may be because it has got excess working capital. For example, it may have allowed it stocks to rise too much, allowed its customers to take too long to pay outstanding bills or not taken enough credit from suppliers.
Managing Cash Flow Problems
If a business wants to manage its cash flow better and improve its cash flow position, it needs to start doing some reliable and more effective cash flow forecasting. It’s a key management technique. Second, it needs to do everything it can to keep costs under control because losses or low profits are the main cause of poor cash flow. Then it needs to look at all aspects of the way it manages working capital. Finally, of course, if it’s got a cash flow problem that might indicate that it’s got the wrong kinds of finance. That might be the moment to have a look again at the different mix of finance that the business users.
Managing Working Capital
Working Capital is often the short term fix to a cash distribution problem. Don’t forget that the business needs to invest its finance in managing the activities of the business. For example, if it’s a manufacturer or retailer, it will need to invest in inventories or stocks. Most businesses also allow customers to take time to pay their debts, trade debt, or trade receivables. But on the other hand, a business could also take some time to pay its suppliers. You could also initiate a chargeback. What is a chargeback? It is the amount you can recover from people you had paid.
There are some things that could be done to improve the working capital position and therefore improve the cash flow by just looking at stocks or inventories. A business that has a lot of capital invested in stocks or inventories is quite likely to suffer from cash flow problems if the level of stocks is inappropriate for the business. So it should be looking at how much stock it’s holding in the warehouse or within the production system and seeing whether it could reduce stocks.
Reducing stocks should free up some cash back to the business. However, it’s a difficult balance to get it right. On one one hand you want to make sure you don’t hold too much stock, but on the other hand you want to make sure you’ve got enough to handle the demand that the business wants to wear to turn into sales.
Managing Amounts Owed By Customers
Amounts owed by customers is another area where business can quickly improve its cash position, in particular, by implementing what’s known as credit control. This is the way in which a business manages how much is owed to it by its customers. There’s a whole bunch of things that could be done, particularly around better administration and better risk management, that enables the business to keep a tighter lid on the amount that’s owed by customers and how long they pay. The trade receivables or trade deficit days are a key indicator as to how well the business is managing how much is owed by his customers.
This is a short term fix that a business or some businesses can use to release the capital tied up in trade debtors back into the business as cash. What happens here is that the business effectively sells its debts and sells its outstanding invoices to a finance company. That third party business then owns that debt and goes ahead and tries to recover it. So the cash flow benefit here is that you get the money or a proportion off the money into the business.