What kind of money should a company keep on hand or “on short call” at a bank? The more cash which is on hand, the simpler it will be for the company to meet its bills as they fall due and to take advantage of discounts. However , holding cash or near equivalents to money has a cost in terms of the loss of earning which otherwise have been obtained by using the funds in another way. The financial manager must try of stability liquidity with profitability.
We have currently introduced the operating cycle, which usually connects investment in working capital with cash flows. Cash flow troubles can arise in several ways.
um Making losses. -If a business will be continually making losses, it will eventually have cash flow problems. Just how long it will take prior to a loss-making business runs into cash flow trouble will depend on. (1). How big the losses are; & (2). Whether depreciation charge is not too young to create a loss despite an income surplus. In such a situation, the cash flow troubles might only begin once the business needs to replace fixed property.
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-In a period associated with inflation, a business needs ever increasing amounts of cash just to replace used-up and worn-out assets. A business can be creating a profit in historical cost construction terms, but still not be receiving enough cash to by the replacement assets it needs.
o Growth. -When a company is growing, it needs to acquire, & to aid higher amounts of stocks & debtors. These addition assets must be paid for somehow (or financed by creditors).
o Seasonal Business. -When a company seasonal or cyclical sales, it might have cash flow difficulties at peak times of the year, when (1). Money inflows are low but (2). Cash out flows are high, probably because the business is building up the stocks for the next period of high sales.
o One-off Items of expenditure. -The made might occasionally be a single the nonrecurring item associated with expenditure that corrects a cash flow problem, such as (1). The repayment of loan capital on maturation of the debt. Business often attempts to finance such long repayments by borrowing again. (2). the purchase of an exceptionally expensive item. One example is -A small or medium -sized business might decide to buy a free keep property which then stretches its cash resources for several months or even yrs.
Methods of Easing Cash Shortages
The steps that usually taken by a company if a need for cash arises & when it cannot obtain resources from any other source such as a loan or an increased overdraft are as follows.
o Putting off capital expenditure. -It might be imprudent to postpone expenditure on fixed assets which are needed for the development growth of the business. On the other hand, some capital expenditures are routine and might be postponable without serious outcomes. The routine replacement of motor vehicles is an illustration. If a company’s policy is to substitute company cars every two years, but the company is facing a cash shortage, it might decide to replace cares about you every three years.
o Accelerating money inflows which would otherwise be expected in a later period. -The most obvious way of bringing forward cash inflows would be to press debtors for earlier transaction. Often , this policy will result in a loss of goodwill & problems with customers. There will also be very little scope with regard to speeding up payments when the credit time period currently allowed to debtors is no more than the norm for the industry. It might be possible to encourage debtors to pay faster by offering discounts for previously payment.
o Reversing past expense decisions by selling assets formerly acquired. -Some assets are less crucial to a business than others & so if cash flow problem are assist, the option of selling investments or house might have to be considered.
o Negotiating a reduction in cash outflows so as to postpone or maybe reduce payments. -There are several ways this could be done,
Longer credit may be taken from suppliers. However , if the credit period allowed is already generous, creditors might be very reluctant to extend credit score even further & any such extension of credit would have to be negotiated properly. There would be a serious risk of having additional supplies refused.
1 . Loan substitutes could be rescheduled by agreement with a bank.
2 . A deferral from the payment of corporation tax could be agreed with the Inland Revenue. Company tax is payable nine months after a company’s year end. But it might be possible to arrange a postponement with a few months. When this happens, the Inland Income will charge interest on the outstanding amount of tax.
3. Dividend payments might be reduced. Dividend payments are discretionary cash outflows, although a company’s directors might be constrained by investors expectations, so that they feel obliged to pay dividend even when there is a cash lack.