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causes of cash flow problems

The document outlines various causes of cash flow problems, including lack of planning, poor credit control, allowing customers too long to pay, rapid expansion, and unexpected events. It also discusses methods to improve cash flow by increasing cash inflows and reducing cash outflows, highlighting strategies such as managing trade receivables and payables. Each method is evaluated for potential drawbacks, emphasizing the need for careful financial management.

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Munashe Chitawa
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2 views

causes of cash flow problems

The document outlines various causes of cash flow problems, including lack of planning, poor credit control, allowing customers too long to pay, rapid expansion, and unexpected events. It also discusses methods to improve cash flow by increasing cash inflows and reducing cash outflows, highlighting strategies such as managing trade receivables and payables. Each method is evaluated for potential drawbacks, emphasizing the need for careful financial management.

Uploaded by

Munashe Chitawa
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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10/06/24 Causes of cash flow problems

(i) Lack of planning - Cash flow forecasts help to predict future cash problems.
o Financial planning is used to predict potential cash flow problems so that managers can
take action to overcome them in due course.
o Thus insufficient planning for cash flow management causes cash flow problems.

(ii) Poor credit control - credit control involves monitoring debts to ensure that credit periods
are not exceeded.
o Involves recording who has paid, who is paying on time and those not paying on time.
o If credit control is poorly managed, trade receivables will not be followed up for payment
and potential bad debts will be missed.
o Bad debts are unpaid customer bills that are unlikely to be ever paid.

(iii) Allowing customers too long to pay debts - businesses offer trade credit to customers
to remain competitive.
o Customers may have choice between different suppliers and they choose suppliers who
sell on credit rather than cash since this improves their cash flow.
o However allowing customers too much time to pay debts reduces short-term cash inflows,
causing cash flow problems.

(iv) Expanding too rapidly – Overtrading occurs when a business expands rapidly without
obtaining all the necessary finance, resulting in a cash flow shortage.
o The business will be having to pay for expansion costs, increased wages, and materials
before it receives cash from additional sales.
o This causes cash flow shortages.

(v) Unexpected events – increase costs which can lead to unpredicted negative net cash
flows.
o e.g. the breakdown of key production equipment which must be replaced immediately or
the entrance of a new competitor with better quality products reduces demand and makes
the original cash flow forecast inaccurate.
Methods of improving cash flow
• Improving net cash flows can be done by:
o increasing cash inflows
o reducing cash outflows

Methods of increasing cash inflows and their possible drawbacks


Improving cash flow by managing trade receivables
o Trade receivables can be managed to improve cash flow by;
(i) Not extending credit to customers or asking customers to pay more quickly:
Evaluation: However customers who expect credit seek alternative suppliers who offer credit.

(ii) Debt factoring - selling claims on trade receivables to a debt factor for an immediate cash
payment.
Evaluation: However the payment is received at a discount since debt factors will not pay the
full value of the debt.
(iii) Finding out the debtors payment history – to determine whether the customer is
creditworthy. e.g. by requiring references from the bank, past traders or using a credit enquiry
agency.
o However, this may discourage new customers without a trade record.
o Also, hiring credit enquiry agencies is an expense to the business.

(iv) Offering cash discounts for prompt payment – this encourages quick receipts of cash.
However, discounts are an expense which reduce the firms profit margin on sales.
Methods to reduce cash outflows and their possible drawbacks

Improving cash flow by managing trade payables


• Trade payables can be managed to improve cash flow by:
(i) Purchasing more supplies on credit and not cash – enables the business to retain cash.
o Evaluation: However, the business loses cash discounts from suppliers for quick cash
payments
o Also this method is only applicable for businesses with a good credit payment record.
o Suppliers may refuse to offer credit to other businesses.
(ii) Extend the creditors payment period i.e. the period of time taken to pay creditors to
retain cash and improve cash flows.
o Evaluation: However, slow payment by larger businesses is a burden to small businesses
which supply them.
o Also suppliers become reluctant to supply products or offer services to a business which
pays its debts late.
o The business suffers from interest charged for late payments.

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