Cash Flow Question

From 2005 Past Paper


Identify 4 sources of cash flow problems and suggest one solution for each source you have identified.

Sources of cash flow problems:

too much money tied up in stock
allowing customers too long to pay
debtors not paying on time
high levels of borrowing along with high interest rates
high drawings
low sales
high expenses
purchasing capital equipment

Solutions
introduce JIT
offer discounts to encourage prompt payment
offer discounts/promote cash sales
sell any unused assets
reduce loans by eg increasing number of investors
debt factoring
sale and leaseback
extended credit
arrange overdraft/loan
cut costs
promote product or serv

Reason for Preparing Budgets (2006 Past Paper)

Why are Budgets prepared? Remember there are different types of budgets.


Monitoring and control – comparison of actual performance with the budget

Allows the firm to take corrective action, eg increase production to meet forecast sales

Allows managers to organise resources

Sets targets for management and employees to reach

Individual managers/departments can be allocated budgets so that control is tighter

Cash budgets highlights periods when a negative bank balance is expected so finance can be arranged in advance

Forecasting cash surpluses allows a firm to invest money in assets

Allows managers to identify problems

Offer solutions

Plan for the future

Sources of Finance

Leasing
Renting of vehicles or equipment
More expensive in the long term than buying the asset
Asset is replaced when obsolete
Spread payments

Share issue
Dividends have to be paid to shareholders
Loss of control possible
Can generate large amounts of money/capital

Debentures
A long term loan to plcs
Debenture holders receive fixed interest
Debenture holders receive the money lent back

Venture Capital (think Dragons' Den)
Venture capitalists lend money when banks think it is too risky
Large amounts lent but interest is high
Part ownership often needed in exchange for finance

Hire purchase
A deposit is required and the rest of the price is paid in instalments
Ownership remains with the finance company until the last instalment
is made

Mortgage
A large sum of money borrowed from a bank or building society to
purchase property
Monthly repayments required (interest)
Long term borrowing eg 25 years

Grants
Some of the money paid by eg Local Authority or Government
No need to repay a grant
May be given if organisation is creating jobs in an area of high
unemployment etc

Sale of asset (Divestment)
Equipment or property which is no longer required is sold off to raise
cash

Retained profits
Profits made are not distributed to the owners but kept back for
reinvestment

Budgets

Budgets are a financial plan used by firms to allocate resources for the future.

Why do we use them? ****

Cash Flow

Cash Flow is a statement which lists all likely inflows and outflows of cash on a monthly basis.

Many businesses fail due to poor cash flow.

A prediction so adjustments can be made to expenditure or income,

Such as leasing equipment
Increasing revenue
Invest in assets for the future
Borrowing arranged.

More likely to convince lender if it can be shown that the money borrowed could be paid
back.
It could be used when applying for bank loan
Or when making comparisons between years.

Businesses must stick to the cash flow forecasts where possible.

Cash Flows can help arrange short-term loans and overdrafts which can be arranged ahead of time which helps keep costs down.


LIMITATIONS OF CASH FLOW
Previous records have to be accurate in order to aid future planning.
Does not take into account one-off happenings, it is based on what is known and regular.

Why use Accounting Ratios?

Ratios are used in business because they are measureable and can be used in the decision-making process.

It allows companies to compare their performance with competitors.

It can judge how profitable a firm is and how liquid (ability to pay off debtors) it is.

It also allows firms to compare their own yearly performance.

It can be used by banks as a measure to grant or deny loans.

There are some problems however:

Ratios are historic, so info may be out of date.

External factors are not taken into consideration. For example, there could be a worldwide recession, or an event in the firm's life that has a serious affect on it. Perhaps a natural disaster like Hurricane Katrina or the burning down of a warehouse (though hopefully insurance would come into it!).

Other factors have to be taken into account, like the ability of the workers

However it has to be with similar competitors (you have to compare like with like, ie Tesco judging performance with a local grocer is pretty silly!)


Remember the different Ratios?

GROSS PROFIT PERCENTAGE

NET PROFIT PERCENTAGE

RETURN ON CAPITAL EMPLOYED

WORKING CAPITAL RATIO (CURRENT RATIO)

ACID TEST RATIO

RATE OF STOCK TURNOVER

What does a Balance Sheet show?

A Balance Sheet is a snapshot of how much a business is worth at that given point in time.

It lists the value of the Assets (what it owns) and the Liabilities (what it owes).

Balance Sheets also show how the business is financed (where the start-up money came from, loans from banks, family & friends etc).

What does a Profit and Loss Account show?

A Profit and Loss Account is used to illustrate the difference between the businesses Gross Profit (or it could be a loss) and the expenses that have been incurred.

From this we then come to what is called the Net Profit, which is the money made from sales and trading less all other expenses.

The Profit and Loss Account is calculated over a financial period, normally one year. Many firms financial year is April to April, but not always.