What kind of money should a company keep on hand or even “on short call” at a bank? The more cash which is on hand, the simpler it will be for the company to meet the bills as they fall due and to take advantage of discounts. However , holding money or near equivalents to money has a cost in terms of the loss of making 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 funds with cash flows. Cash flow complications can arise in several ways.
u Making losses. -If a business is continually making losses, it will eventually have got cash flow problems. Just how long it will take before a loss-making business runs in to 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 a cash flow surplus. In such a situation, the cash stream troubles might only begin when the business needs to replace fixed assets.
o Inflation. -In a period of inflation, a business needs ever increasing amounts of cash just to replace used-up and worn-out assets. A business can be making a profit in historical cost sales terms, but still not be receiving enough cash to by the replacement property it needs.
o Growth. -When a business is growing, it needs to acquire, & to aid higher amounts of stocks & borrowers. These addition assets must be covered 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, maybe because the business is building up its stocks for the next period of higher sales.
o One-off Items of costs. -The made might occasionally be a single the nonrecurring item associated with expenditure that corrects an income problem, such as (1). The pay back of loan capital on maturity of the debt. Business often tries to finance such long repayments by borrowing again. (2). the buy of an exceptionally expensive item. For example -A small or medium -sized business might decide to buy a free hold property which then stretches its money resources for several months or even many years.
Methods of Easing Cash Shortages
The steps that usually taken by a company every time a need for cash arises & when it cannot obtain resources from any other source such as a loan or a greater overdraft are as follows.
o Postponing capital expenditure. -It might be thoughtless to postpone expenditure on set assets which are needed for the growth growth of the business. On the other hand, several capital expenditures are routine and might be postponable without serious consequences. 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 money shortage, it might decide to replace cares every three years.
o Accelerating cash inflows which would otherwise be expected within a later period.
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-The most obvious method of bringing forward cash inflows would be to press debtors for earlier payment. Often , this policy will result in a loss of goodwill & problems with clients. 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 more quickly by offering discounts for previously payment.
o Reversing past investment decision decisions by selling assets formerly acquired. -Some assets are much less crucial to a business than others & so if cash flow problem are provide, the option of selling investments or home might have to be considered.
o Negotiating a decrease in cash outflows so as to postpone as well as reduce payments. -There are several ways this could be done,
Longer credit might be taken from suppliers. However , if the credit score period allowed is already generous, lenders might be very reluctant to extend credit score even further & any such extension associated with credit would have to be negotiated thoroughly. There would be a serious risk of having further supplies refused.
1 . Loan substitutes could be rescheduled by agreement with a bank.
2 . A deferral from the payment of corporation tax might be agreed with the Inland Revenue. Corporation tax is payable nine months following a company’s year end. But it may be possible to arrange a postponement by 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 an industry¡¯s directors might be constrained by investors expectations, so that they feel obliged to pay for dividend even when there is a cash shortage.