The main aim when solving Cash Flow problems is to improve the cash position of the business, not to increase sales revenue or maximize profits. Growing the business and increasing profitability are completely different tasks from fixing the cash problem that the firm has.
Improving the Cash Flow position of a business requires effective Working Capital management. This includes the business successfully managing its Current Assets and its Current Liabilities. Almost always, the solution to the cash problem is to deal directly with the causes of common Cash Flow problems.
The cash position of the business will be improved after achieving the following three generic tasks:
- Improving Cash Inflows.
- Reducing Cash Outflows.
- Seeking alternative sources of finance to combat negative Closing Balance.
Tips for Solving Cash Flow Problems
Let’s take a look at different methods of improving Cash Inflows, reducing Cash Outflows and seeking alternative sources of finance to combat negative Closing Balance.
1. How to improve Cash Inflows?
Here are the main ways to increase Cash Inflows in a typical business organization. All these methods serve the purpose of receiving the cash sooner.
Method 1: Cash payments only
The business should accept only cash payments from customers at the exact moment when the products are sold. Customers can be encouraged to pay on time by offering them price discounts.
Method 2: Shorten trade credit given
The firms can reduce the length of trade credit period given to their customers. Cash can be brought in by reducing credit terms from three months to one month. However, some customers may switch to competitors who can offer them extended credit terms.
Method 3: Change the pricing policy
Reducing prices of products can help the company to convert excessive stocks into cash. Especially products that are not the best sellers, are in the decline stage of the Product Life Cycle or have lots of substitutes. In this way, the business will improve its immediate liquidity and offload any excessive inventories.
Method 4: Improve Product Portfolio
The business can improve its sales, hence more cash flowing into the business, by providing a wide Product Portfolio with many varied products. Even with poor sales of one product, the overall sales performance can be offset by better sales in other markets.
2. How to reduce Cash Outflows?
Here are the main ways to reduce Cash Outflows in a typical business organization. All these methods serve the purpose of the cash leaving the business later.
Method 1: Delay payments to suppliers
The business should pay for supplies as late as possible, specifically on the last day of the credit period. In this way, Cash Outflows can be delayed until the last moment.
Method 2: Seek preferential credit terms
The business should negotiate longer trade credit terms with suppliers to pay bills as late as possible. Cash Outflows can be reduced by extending credit terms from one month to three months to pay its suppliers and creditors. However, some suppliers may cancel any discounts offered with the purchase, demand immediate cash payment on delivery or even refuse to supply at all.
Method 3: Seek alternative suppliers
The firm can spend some time on finding new suppliers who can offer more competitive prices. While the administrative costs and the time are needed to investigate and negotiate new better deals, cheaper stocks will help to reduce Cash Outflows.
Method 3: Delay spending on purchasing capital equipment
Not buying new Fixed Assets such as Premises (Land and Buildings), Equipment (Machinery) and Vehicles will significantly reduce the large amounts of cash leaving the firm. However, while delaying the purchase of Fixed Assets until the cash flow improves is also an option, the efficiency of the business may fall making expansion to become very difficult.
Method 4: Use leasing more often
If the company must acquire necessary capital equipment, it can use leasing instead of purchasing it outright. Thanks to leasing an asset, the company can own it without any large cash outlay. Thus, leasing can reduce the burden on Cash Outflows as it is cheaper in the short-term to rent assets instead of buying them. Unfortunately, the asset is not owned by the business and leasing charges must be paid in the meanwhile causing higher annual overheads.
Method 5: Reduce expenses
One of the most obvious ways of reducing Cash Outflows is to cut overhead spending without negatively affecting the output. By identifying Fixed Costs that can be reduced without compromising product quality, the firm can save huge amounts of money. Such expenses can include luxury items purchased by directors and senior managers or excessive advertising spending.
Method 6: Better control stock
Reducing stock levels will help to reduce the amount of cash being tied up in excessive inventory. This method will work well for manufacturers of mass market products, but may not work at all for the firms that offer a service as these do not hold much stock. Inventory can be managed in the following ways:
- Keep smaller inventory levels. Cash tied up in stocks can be minimized.
- Use inventory control system. Use inventory management systems to record past sales, current inventory levels and new orders. The inventory control system will also help operations managers to reduce inventory losses through damage, wastage or obsolescence.
- Switch to Just-in-time Inventory. Working Capital tied up in inventories can be minimized to zero by ordering inventory from suppliers only when new orders have been received.
3. Seeking alternative sources of finance to combat negative Closing Balance.
Here are the main ways to seek alternative sources of finance to combat negative Closing Balance in a typical business organization. All these methods serve the purpose of having access to cash during times of negative Cash Flow at the end of the month.
Method 1: Use overdraft
With the use of overdraft, the business can temporarily take out more money up to an agreed limit than it has in its corporate bank account. This flexible loan gives the firm an immediate access to cash during dire times of negative Cash Flows leading that may lead to negative Closing Balance. While interest rates can be high along with additional overdraft arrangement fees, overdrafts can be a lifesaving solution for firms facing a temporary liquidity crisis.
Method 2: Take short-term bank loan
A fixed amount of money can be borrowed from the bank for an agreed length of time with the interest costs to be paid regularly and the loan repaid by the due date.
Method 3: Use sale and leaseback
Large cash receipts obtained from selling off some of its Fixed Assets will boost Cash Inflows generating much-needed cash. When the assets are sold to an external finance company and then leased back from the new owner, the cost burden to the business will only be the leasing costs as a part of annual overheads. So, sale and leaseback will provide large Cash Inflow in exchange for smaller Cash Outflows. However, the assets do not belong to the business anymore, so a loss of potential profit, if the asset rises in value, will be an opportunity cost. And, the assets cannot be used as collateral for future bank loans either.
Method 4: Use debt factoring
External debt-factoring companies can buy the customers’ outstanding bills from a business and offer immediate cash minus the handling charges. In this way, the business will get immediate access to cash. But, only about 90–95% of the debt will be paid by the debt-factoring company which reduces the firms’ profit.
Method 5: Seek government assistance
Government grants and subsidies can help the business to boost the Cash Flow position. Many governments are willing to help struggling businesses with temporary cash injections. Otherwise, bankruptcies could lead to job losses, higher social welfare costs or even social unrest.
Method 6: Sell Fixed Assets
Whilst cash receipts obtained from selling off some of its redundant assets will boost Cash Inflows generating much-needed cash, it might take a very long time to liquidate any obsolete or unused assets. This will also be a one-off only cash injection. Hence, without preventing having negative Net Cash Flow repetitively, selling assets may be a temporary solution only. What is more, the assets might be required at a later date for business growth or used as collateral for future bank loans. Therefore, selling Fixed Assets by a business is not advisable unless totally necessary for business survival.
Without sufficient Working Capital, the business may be unable to buy more supplies, or pay suppliers, or offer trade credit to important customers. All these factors could lead to the business closing down. Therefore, it is very important to find solutions to Cash Flow problems as soon as possible.
