Page 156 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Unit 9: Cash Flows Forecasting and Treasury Management

(f) Considering the firm’s original terms, collection experience, and level of sales, if Notes
the finance manager decides to shorten the collection period by tightening the
credit term to 2/10 not 30. If bad debt losses remain 2 per cent of gross sales and
collection percentages are expected to .remain at 60 and 40 per cent but the gross
sales decline to ` 9,00,000. Would this decision be advisable?

Self Assessment

Fill in the blanks:
7. …………….typically use scheduling for daily cash forecasts, especially for short horizons.
8. The …………………..the horizon, the more detail shown in the cash forecast.
9. ………………….refers to the risk regarding the firm’s future levels of sales.

9.6 Reasons for Cash Flow Problems

A cash flow problem arises when a business struggles to pay its debts as they become due.
Business has a cash flow problem if any of these in the cash flow statement:

1. Cash outflows are constantly bigger than cash inflows
2. Business keep increasing in bank overdraft (closing balance is minus)
3. Business keeps taking out other kinds of loan or put in more capital to keep the firm going

Notes A cash flow problem is not necessarily the same as experiencing a cash outflow. A
business often experiences a net cash outflow.

Example: When making a large payment for raw materials, new equipment or where
there is a seasonal drop in demand.
Working capital consists of cash, invoices sent by the business which customers have not yet
paid, and stock. Of these three, only cash can be used to pay outstanding bills.

Notes The more of the working capital is tied up in stock and outstanding invoices, the
more likely it is that the business has a cash flow problem.

However, when cash flow is consistently negative and the business uses up its cash balances,
then the problem becomes serious. There are a lot of popular phrases used in describing financial
issues experienced by many businesses. A couple such phrases are “Cash is King” or “Cash is the
Life Blood of a Business.” Both are phrases that become very real at some point in time with
most businesses.
A few years ago a study was done on the financial status of companies filing bankruptcy. The
outcome of that research turned up the fact that over 50% of the companies that filed bankruptcy
showed a year-end profit. It wasn’t profitability that created their problems, it was cash flow.
They lacked sufficient liquidity (cash) to pay their creditors based on agreed upon terms or
contracts. Profitability only indicates that your sales were sufficiently larger than your expenses
but it doesn’t mean that you have yet received the income generated by those sales. You may

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