Why cash is important to a business?
If a business runs out of cash or have too little cash, it will face major problems:
Unable to pay workers/ suppliers/ landlord/ government
Production of goods and service will stop --> workers will not work for no pay --> suppliers will not supply goods if the are not being pay
Business might be forced into liquidation ( selling up everything they owns to pay debt)
Cash inflow: the sums of money received by a business during a period of time
Sale of products for cash
Payments made by debtors ( debtors are customers who already purchased products but did not pay in time )
Borrowing money from external resources
Sale of assets
Investors
Cash outflow: the sums of money paid out by a business during a period of time
Purchasing goods/ material
Paying wages/ salaries
Purchasing non-current (fixed) assets
Repaying loans
Paying creditors of the business ( other firms which supplied items for the business not were not pay immediately)
Cash flow cycle: shows the stages between paying out of cash for labour, materials, and so on, and receiving cash from the sale of goods
Cash needed to pay
For essential material and other cost
Goods produce
Goods sold
Cash payment received for goods sold
If the business do not have enough cash for stage 1:
Not enough materials and other requirements could be purchased --> output and sale would fall
If the business insist customer to pay cash at stage 4 because of money shortage:
It might lose the customer to a competitor who could offer credit
if a business had insufficient cash to pay its bills :
Liquidity crisis and it might be forced out of business by its creditors
Cash flow is not profit
Can a profitable business ran out of cash?
Allowing customers too long a credit period ( perhaps to encourage sale)
purchasing too many fixed asset at once
Overtrading ( expanding too quickly and keeping a high inventory level )
Cash flow forecasts: an estimate of future cash inflow and outflow of a business, usually on a month by month basis. This shows the expected cash balance at the end of each month.
How much cash is available for paying bills/ repay loans/ buying fixed assets
How much cash in the bank need to lend--> avoid insolvency
Whether the business is holding too much money or not
Uses of cash flow:
Starting up a business
Running an existing business
Keeping the bank manager informed
Managing cash flow
How short term cash flow problems can be overcome:
Increasing bank loans: interest must be paid--> reduce profit
Delaying payments to suppliers: suppliers could refuse to supply
Asking debtors to pay more quickly : customers may purchase fro another business
Delay or cancel purchases of capital equipment: the long term efficiency of business could decrease without up to date equipment
How long term cash flow problems can be overcome:
Attract new investors
cutting cost and increasing efficiency
developing new product to attract customers
Working capital: capital available to a business in the short term to pay for day to day expenses
Working capital = Current assets - Current liabilities
Working capital may be held in different forms:
Cash is need to pay day to day costs and buy inventories
value of a firm's debtors is related to volume of the volume of production and sales
the value of inventories may cause the production to stop
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