In this assignment, I will be analyzing the cash flow problems a business might face as they trade. A cash flow forecast is used by companies to estimate how much a business will make over a period of time. It is important because if keeps the company from going bankrupt, it is used to prepare for future problems, set targets and many more but there are cash flow problems a business might face. Cash flow forecasts may have some advantages like it helps businesses plan for unexpected bills that may arrive in the future of the business. It also helps the business get a bank loan if positive and lastly, it helps the business see when they will need a loan or any source of finance. Just as it has its positives it also has some negative aspects such as; they are only a rough estimate, it only accounts for a small portion of the year and also it might not take into account payments that may affect the business in the future. Some of the problems a cash flow forecast may face will be;
Low profits; Profit is the main reason why businesses operate and it is very important in the life of a business and so low profits or a lack of it can be the main cause of cash flow problems in every business. A business might estimate a certain amount of money as profit at the end of every financial year but will not be able to record that amount due to different reasons. The business might not be able to clean the number of houses that they estimated to clean at the end of every day, week or month as a result, less money will be made then what was estimated. For example, if the business estimates to make about £26,350 at the end of the year but makes £24,500, it is going to affect the business.
Another problem a business might face because of a cash flow problem will be overtrading. This is when a business expands the company quickly without having the resources to accommodate the expansion. This is a problem because if the company gets more deals than expected for about a month or two, they might go on and employ more people than needed and might end up again opening other branches and at the end of that deal, the company will find it difficult to maintain the other branches and will also find it difficult to pay the new employees. Other disadvantages will be that, there will be poor creditworthiness of the company and so it will be difficult to raise finance form other business lenders and then there will be lack of finance which will lead to delayed repairs and maintenance of the company equipment. It will lead to loss of capital because the capital will be used to open other branches or buy extra equipment which will not be needed by the company. One way to avoid overtrading will be to arrange long term finance, reduce the company’s stock levels, reduce marketing spend and be more realistic about customer acquisition and look at ways to ease cash flow for example the company should try leasing items instead of buying them.
Allowing the customers too much credit; when trade debtors (customers who owe the business some money) are given too much credit, they fail to pay whatever they need to pay. Offering too much credit will always create a negative cash flow for the business. Offering the customers too much credit can have its advantages. For example, it is going to attract new customers and build a relationship with the old ones, it is also going to give the company a competitive edge because the customers will want to trade with a company that offers their customers credit. On the other hand, the disadvantages weigh more because, the collection of the credit can be another problem and so the company will have to turn over to a debt collection agency to collect the money and as a result the company will have less money than the customers owed them. There will be added accounting because the company will need to hire an extra employee to track the records of the debtors and at the end of the month, some of the money will go to the employee as salary and in the worst case that the employee doesn’t pay back the money owed the company will have to write off the debt as a bad debt. One way the company will be able to avoid this problem is not to offer too much credit to the customers or reduce the days the customers can hold credit. For example, if my window cleaning business offers 90 days for a customer it should be reduces to about 60 days and also it will be better if the company does not offer credit to every customer. This will be able to help solve this problem.
Too much production capacity by the company can also be a problem for the cash flow. This is when the company spends more money on fixed assets. This can be a problem especially when short term finance is being used and it is also difficult to turn into cash. If my business decides to buy lots of goods that will not be used immediately it will be a problem because it is going to cost extra money to maintain some of the goods
Excess inventories held by the companies is also, a cash flow problem. This is because the company will waste money buying more window cleaning products than necessary for that moment because of this, the company will have lots of products but less houses to clean and so the products will not be of use.
Seasonal demand is also another cash flow problem. Depending on the season, the company might estimate to clean a certain number of houses using the cash flow forecast. This can be very unstable because they might have more cleaning request than was expected in a month and the other less requests than was also estimated. For example, in some seasons like winter, home owners might not want their windows to be cleaned as much because of the weather conditions and so the company might estimate to clean about twenty houses in a month but they might end up cleaning about eleven houses because of this, the company will record less money than they estimated to have.