Improving Cash Flow

Options to improve cash flow Bank overdraft An agreement whereby the holder of a current account at a bank is allowed to withdraw more money than there is in the account. The agreement specifies the maximum level of the overdraft

Bank overdraft Advantages Administrative convenience Flexibility Interest only paid on the amount owe No security necessary Disadvantages Variable interest payments Higher interest rates Threat of immediate repayment required

What causes cash-flow problems? Seasonal demand Overtrading Over-investment in fixed assets (not enough working capital left) Credit sales Poor stock management Poor management of suppliers (e.g. credit periods) Unforeseen change Losses or low profits

Short-term loan A sum of money provided to a firm or an individual for a specific, agreed purpose. Repayment of the loan will take place within 2 years or possibly less More usually used for purchasing fixed assets, but may avert a cash-flow problem if a business is expanding rapidly

Short-term loan Advantages Fixed interest payments make budgeting much easier Lower interest rate than a bank overdraft Disadvantages Higher interest payments as interest is on whole of the sum borrowed Security is required (collateral)

Debt Factoring When a factoring company buys the right to collect the money from the credit sales of an organisation Eg a factoring company may pay a firm 75% of its sales immediately + 15–20% on receipt of the debt Firm therefore loses some revenue (5-10%) depending on factoring company’s charge for its services

Factoring Advantages Improved cash flow in the short term Lower administration costs Reduced risk of bad debts Increased efficiency Disadvantages Loss of revenue High cost Customer relations problems

Sale of assets Advantages Can raise a considerable sum of money Improve profitability if no longer required Disadvantages Possibility of receiving low value for the asset if need a quick sale Reduced ability to make a profit – fundamental rule is that a firm should not sell assets to improve liquidity

Sale of assets When a business transfers ownership of an item that it owns to another business or individual, usually in return for cash

Sale & Leaseback When assets that are owned by a firm are sold to raise cash and then rented back so that the company can still use them for an agreed period of time

Sale & Leaseback Advantages Cash inflow Flexibility Lower costs such as maintenance Greater focus Disadvantages Rent – likely to pay more in the longer term Reduced assets Eventual loss of the use of the asset

Additional methods Improved working capital control Cash management Debt management Debtors owe the business money Obtain a credit rating Managing credit control Stock management Diversity its product portfolio Improved planning, monitoring & control procedures Hold a contingency fund