Q.2. What are the different classes of cash flows? How do cash flow problem arise?

Discuss the various methods to overcome this problem. Answer. Cash flow is essentially the movement of money into and out of your business; it's the cycle of cash inflows and cash outflows that determine your business' solvency. Cash flow analysis is the study of the cycle of your business' cash inflows and outflows, with the purpose of maintaining an adequate cash flow for your business, and to provide the basis for cash flow management. Cash flow analysis involves examining the components of your business that affect cash flow, such as accounts receivable, inventory, accounts payable, and credit terms. By performing a cash flow analysis on these separate components, you'll be able to more easily identify cash flow problems and find ways to improve your cash flow. A quick and easy way to perform a cash flow analysis is to compare the total unpaid purchases to the total sales due at the end of each month. If the total unpaid purchases are greater than the total sales due, you'll need to spend more cash than you receive in the next month, indicating a potential cash flow problem.

CLASSES OF CASH FLOW STATEMENT: The statement of cash flows classifies cash receipts and cash payments by operating, investing, and financing activities. Transactions and other events characteristics of each kind of activity are as follows: 1. Operating activities 2. Investing activities 3. Financing activities These business activities are briefly explained below: Operating Activities: Operating activities involve the cash effects of transactions that enter into the determination of net income, such as cash receipts from sales of goods and services and cash payments to suppliers and employees for acquisitions of inventory and expenses. Investing Activities: Investing activities generally involve long-term assets and include:

-lived assets.

Financing Activities: Financing activities liability and stockholders; equity items and include: repaying the amounts borrowed.

of, their investment.

HOW THE CASH FLOW PROBLEM ARISES?

Too Many Debtors: Failing to keep control of your debtors is one of the main causes of having bad debts and so it is important that you follow up immediately on any late payments. At the same time, it is important that you keep good relations with your customers, particularly the important ones. When customers fail to pay you back at the agreed time, it can have a major impact on your cash flow particularly if the money owed is a significant amount. Too Many Creditors Everyone takes credit where it is offered, but having too many creditors can prove fatal particularly if you offer credit to your own customers. Your payment to creditors may be dependant on whether your debtors pay you on time. If they dont, then it could result in you failing to pay off your debts and consequently you could be faced with heavy interest charges or blocked further credit giving you a poor reputation.

Over-Financing Borrowing excessive amounts of money to finance your business is a route that many new start-ups, in particular, have taken - and failed. We all know that borrowing costs money (mainly through interest rates) and so it is important that you acknowledge these charges (including terms and conditions) whenever you apply for finance.

Increased borrowing can lead to bigger interest rates and tighter repayment schedules, consequently reducing your control of the business. If you take out any secured loans, your security (be it your home, business assets, etc) is always at risk if you fail to meet payments. Overtrading Overtrading is caused when a business sells more than it is capable of selling with respect to its current cash levels. If payments are made precisely at the time of sale (i.e. no credit is offered), the risk of overtrading can be reduced. Where credit is involved, the effect it can have on cash flow can be disastrous. Sometimes it costs to sell, i.e. for those customers that take credit, you do not have the money in your hand until it is paid to you at the agreed time (credit period). This may encourage the need for borrowing money through, say, loans or overdrafts to compensate. The pattern here is: more selling by credit leads to more borrowing. This may seem normal to most businesses, but for those businesses that fail to meet payments on any money borrowed will face the consequences. Failing to meet payments may be influenced by your debtors failing to pay you on time. Over-Investment If you have money in your business available to you for spending, you may immediately be tempted to purchase assets such as machinery, vehicles, premises, etc. This can often be a direct route to business failure. It is good management to have funds available at hand should any unexpected costs be incurred. In conclusion, over-investing in assets can leave your business short of cash and further leave you unable to finance daily operations and unexpected costs (late payment interest, equipment breakdowns, tax demands, etc).

Poor Stock Control Buying in bulk can seem beneficial at the time, but holding excessive amounts of stock ties up money in unproductive assets, particularly if the stock is not sold on quickly. If you stock raw materials and/or finished products, effective stock control is the key. The costs of storage can also add up and so such costs should be considered when buying in bulk.

Managing a real cash flow crisis: The key to understanding your position is a cash flow forecast. At this stage you usually need to concentrate on the short term and prepare a forecast on a weekly basis, but in extreme cases you may need to prepare one on a daily basis, covering only the next few weeks.

The cash flow forecast will be a vital document, for: 1. Actively managing the cash to ensure survival. 2. Obtaining proper advice as to whether to continue to trade (to protect your personal position) and 3. Obtaining and maintaining bank support.

While you have to make reasonable assumptions, cash flow forecasting is a relatively straightforward exercise in planning the expected real cash movements into (cash sales, debtor payments, new investment received) and out of (payments to suppliers, rent, wages, PAYE, loan instalments, VAT payments and so on) the business.

For a weekly forecast, all you are looking to calculate is therefore the cash you are going to get in that week, less the cash you are going to pay out

that week which gives you a net movement ('flow') of cash into or out of the company. Adding or subtracting this net movement from the balance held at the start of the week gives the balance you expect to have at the end of the week. The secret of successful cash flow forecasting is to take a simple and methodical approach, be clear about where you are starting from (is it your cash book balance or per bank statement?), be realistic and prudent in your estimates of values and timings, particularly of cash coming in, leave a contingency to cover surprises, make sure it adds up properly, and always have a note of the key assumptions you are using so your bank or whoever else needs to see it can follow what you have done. Control the cash you have Once you have prepared your cash flow forecast, use it to help control this scarcest of resources and ensure it is used as efficiently as possible:

prioritise and schedule payments to make best use of the available cash. or payments and cancel or restrict the use of credit/charge cards so that cash is not wasted or committed outside the central cash management process.

performance each time you do so to spot variances that need to be investigated or which can be used to improve accuracy. By preparing a cash flow forecast you may also be able to identify where the cash is leaking out. Is it particular branches, sites or parts of the business? You should

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use the cash flow document as an active management tool, both to target these areas for specific reviews and remedial action, and to help you think more widely about what other sources of cash can be identified, or outflows modified to help manage the position. If money tied up in high stock or debtor levels are part of the cause of your cash problems consider bringing in a Lean cash flow process expert to help free this up. Of course the information contained in an article like this can never be a full statement of the legal position as the relevant laws are complex and liable to change.

HOW TO SOLVE THESE PROBLEMS? Invoice Discounting: Invoice discounting is a model of borrowing that instantly releases the cash tied up in your sales ledger. You will pay a monthly fee to the invoice discounter and also pay interest on the net amount advanced. This is in addition to advances received or money repaid. With invoice discounting, as soon as an authorised invoice is issued by your company you can draw down up to the agreed percentage straight away, which frees up your cash flow and allows you to get on with growing you business. Once your customer pays the invoice reconciliation can take place. Invoice discounting enables you to retain control over your sales ledger, which means that also retain responsibility for chasing payments.

Factoring: Much like invoice discounting, factoring involves delegating your accounts to a third party provider to free finance bound to your sales ledger. But, unlike invoice discounting, this form of credit management allows you to receive up to 90% of your invoices value, with the power to lower this amount as your finances fluctuate. Also, the provider is responsible for following up payments on your behalf which can save both administration and staff costs. Also, because this is a larger company than you, they can often get settlement of invoices quicker than you might on your own.

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This model is increasingly popular for those who wish to put less time into administrative aspects and focus more on the growth and expansion of the company.

Overdraft: Increasing the overdraft of your business account gives you instant access to money you may need for immediate purchases. The overdraft charges may prove too costly however, causing you further financial worry.

Loan: Taking out a loan is another option, which provides you with money to cover those essential expenditures. This will cover you in the short term, but is not convenient on a month by month basis. Many businesses find their finances fluctuate monthly, and to be taking out regular loans would prove complicated in administration and repayment. This time consuming process would detract attention away from time and effort that could going into helping your business grow.