Cash Flow
Companies need to control their spending and carefully monitor the cash flow in order to stay in business (solvent).
Cash flow is where money goes in and out of the business.
- Cash flows into the business as products and services are sold.
- Cash flows out of the business when the business has to pay its expenses such as bills, loans, suppliers and wages.
- Net cash flow is the difference between money into the business and money going out of the business.
The difficulty for owners and managers are to make sure there is always a sufficient amount of money to pay expenses that must be paid swiftly, as running low on money is often fatal for the firm.
Insolvency If a business runs low on money and are unable pay its suppliers or staff it is bankrupt (insolvent). The owners must obtain additional sums of money or cease let the business cease to exist. This is a plausible reason why planning ahead and creating a cash flow forecast is essential, as it distinguishes when the business will need an overdraft.
A business can improve its cash flow through the following steps:
Reducing cash outflows:
- Delaying the payment of bills – only spending money from which you can afford without having to use your savings or maybe a business might decide to get a loan to pay the bills.
- Delay purchasing equipment – continue using old equipment providing it can work in a reasonable manner, only obtain new equipment when additional finance is available.
- Securing better trade credit terms – this means that the owners of the business negotiate with the supplier to pay the money over an extended period of time which prevents issues with cash flow.
- Wage cuts – removing non-essential employees or reducing staff wages could be an option, however it is highly unpopular and will upset most of the remaining workers.
Increasing cash inflows:
- Arranging a loan – obtaining a loan from the bank allows the business to survive during hard times.
- Arranging an overdraft – this would assist the organisation if it is in a short-term period cash flow issue.
- Chasing debtors – this makes sure that people who owe money pay it within a set period of time.
- Divestment – selling property and unwanted equipment is a swift way to raise money.