Cash Flow

Question 1

What is working capital?

Answer 1

Working capital (sometimes referred to as net current assets or circulating capital) refers to cash or other liquid assets available to an organization for its daily operations. Working capital is essential to pay for raw materials, utility bills, and staff wages and salaries. Hence, working capital enables the business to function and trade.

Question 2

Liquidity position vs crisis

Answer 2

Liquidity means the extent to which an organization is able to convert its assets into cash.

A liquidity crisis is a situation that arises when a business is unable to pay its short-term debts. This can eventually lead to bankruptcy.

Question 3

The relationship between investment, profit and cash flow

Answer 3

Investment often requires a large initial amount of cash (for purchasing the fixed assets), so this can have a negative impact on the organization’s net cash flow. However, in the long run, the business intends for the investment expenditure to generate a profit for the organization, and improve its net cash flow.

Question 4

Strategies to reduce cash outflows

Answer 4

Negotiate with creditors and suppliers to improve trade credit terms. Securing a longer credit period helps to delay cash outflows.

Opt for leasing capital equipment instead of purchasing such assets.

Reducing stock levels (inventories), as this can reduce cash outflows needed to pay for purchasing stocks. This is particularly important for organizations with a long working capital cycle.

Question 5

Strategies to increase cash inflows

Answer 5

Raising prices of the products the business sells that have few substitutes or a high degree of brand loyalty.

Reduce prices of the products the business sells that have a high degree of competition.

Reducing the credit period helps to improve the cash flow cycle, because customers buying on credit pay within a shorten time period.

Improved marketing strategies to attract customers, raise brand awareness, boost sales and develop customer loyalty.

Use a debt factoring service to chase up outstanding debtors.

Question 6

Strategies to seek additional sources of finance

Answer 6

Businesses will often rely on bank overdrafts or bank loans as additional finance when faced with a liquidity problem. However, external finance incurs interest repayments, which can harm cash outflows.

Secure finance from sponsorships, donations or financial gifts.

Selling shares in a limited liability company in order to raise additional sources of finance. Whilst this could bring in additional cash, it can be an expensive operation, and such option is not available to sole traders and partnerships.

In the worst-case scenario, an organization could sell its fixed assets to raise additional finance.

Question 7

Cash flow vs profit

Answer 7

Cash flow is the money moving in and out of your business, while profit is the money left after all expenses are paid.