5.4 Making financial decisions: improving cash flow and profits

Question 1

Causes for cash flow problems

Answer 1

• Poor management: managers not forecasting and monitoring the business’s cash flow
• Giving too much trade credit: slows business’s cash inflows
• Overtrading: occurs when a business expands rapidly without planning how to finance the expansion
• Unexpected expenditure: examples include breakdown of a machine

Question 2

Methods of improving cash flow

Answer 2

• Factoring
• Sale and leaseback
• Improved working capital control

Question 3

Factoring

Answer 3

Enables a business to sell its outstanding debtors to specialist debt collector (factor)

Question 4

Sale and leaseback

Answer 4

Owner of an asset sales it and then leases it back.
- Short term boost to the business’s finance
- Business has to commit to paying the rent

Question 5

What is working capital?

Answer 5

Working capital is the cash available to a business for it’s day-to-day operations.

Question 6

Improved working capital control

Answer 6

Can be improved by:
- Selling stocks of the finished goods quickly, prompting cash inflows
- Making customers pay on time and offering less trade credit
- Persuading suppliers to offer longer periods of trade credit, slowing cash outflows

Question 7

Profitability

Answer 7

Measures profits against some yardstick, e.g. the sales revenue achieved by the business.

Question 8

Methods of improving profits and profitability

Answer 8

• Increasing prices: may increase revenue without raising total costs (depends on PED)
• Cutting costs: lower costs of production can improve profit margins
• Increasing efficiency: avoiding waste in the form of poor quality and unsaleable products
• Using its capacity as full as possible: profits will be lower if a business has productive capacity that is not being utilised

Question 9

Difficulties of improving cash flow

Answer 9

• Factoring: profit margin is reduced due to cost of factoring
• Sale and lease back: asset is removed forever and rent now has to be paid
• Working capital control: customers may be put off by reduced credit periods + suppliers may be unwilling to extend credit periods

Question 10

Difficulties of improving profit

Answer 10

• Increasing prices: may reduce sales and revenue and attract criticism from customers
• Cutting costs: likely to result in a reduction in quality if inferior raw materials are used + job losses
• Use capacity fully: may cause problems in matching supply with demand = could result in price reductions and lower revenues
• Increasing efficiency: may result in redundancies if technology is introduced