Page 157 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Working Capital Management

Notes have a lot of those profits tied up in A/R and other illiquid assets. This is why so many find
invoice factoring to be a great solution.

Causes of Cash Flow Problems

The causes of poor cash flow can be either external or internal factors.

Did u know? What are external factors?
The external factors are those that occur outside of the business and its control. While we
may not be able to control external factors we can prepare and reduce the risk and impact
of them on our business. Internal factors are those that are within the control of our
business.
External factors can have a large and frustrating influence on small business and its cash
flow. They can also be overlooked by small business as part of the reason for poor cash
flow. If overlooked the small business will not be able to effectively improve its cash
flow.
The main causes of cash flow problems are:
(a) Low profits or (worse) losses: There is a direct link between low profits or losses and cash
flow problems. Remember – most loss-making businesses eventually run out of cash.
(b) Bad debt: Customers that don’t, won’t or can’t pay their bills.
(c) Slow Paying Accounts: Customers that do not pay as agreed and end up using you for an
interest free loan.
(d) Over-investment in capacity: This happens when a business spends too much on production
capacity. Factory equipment which is not being used does not generate revenues – so is
often a waste of cash.
(e) Down-turn in Revenue: Loss of some of your accounts creating a sudden decrease in sales.
(f) Increase in Expenses: A sudden increase in the cost of doing business such as, skyrocketing
fuel costs, unexpected equipment repairs, increased insurance premiums, uninsured costs
from damage claims.

(g) Seasonal demand: Predictable changes in seasonal demand create cash flow problems –
but because they are expected, a business should be able to handle them.
(h) Sudden or rapid growth: Rapid growth with an increase in overhead which is due prior to
receipt of revenue generated from those sales.
(i) Too much stock: Holding too much stock ties up cash and there is an increased risk that
stocks become obsolete (i.e. it can’t be sold).
(j) Under-capitalized: Not having and cash savings or safety net when unusual demands for
cash occur.

(k) Allowing customers too much credit: Customers who buy on credit are called “trade
debtors”. Offering credit to customers is a good way to build revenue, but late payment is
a common problem and slow-paying customers put a strain on cash flow.
(l) Using Cash or Short-term Financing to Purchase Long-term Assets: Using cash or short-
term financing to acquire an asset that should have been purchased with long-term debt
(resulting in lower payments and therefore a reduced impact on cash reserves).

152 LOVELY PROFESSIONAL UNIVERSITY