Q. How cash flow problems arise?
It is significant first to distinguish between profitability and cash availability. The key scheme relates to insolvency since even profitable companies can face insolvency if cash positions are not properly managed.
Therefore cash positions require management to avoid the difficulties associated with cash shortages. Cash shortages are probable to arise in a number of situations. The following isn't an exhaustive list but is likely to represent the most common. Cash flow problems are able to arise due to:
- Continued losses in the business such that cash resources have been drawn-down
- Complications in dealing with inflating costs combined with an inability to raise sales prices proportionately
- Over trading as well as inadequate financing of growth. This is very common with new businesses that aren't able to finance working capital requirements sufficiently. In general such problems are associated with under-capitalised businesses and a lack of recognition that working capital requirements require a large base of long-term capital funding
- Seasonal trading beside ongoing costs. This situation occurs where income from sales is variable according to the time of year but fairly even monthly outgoings have to be met
- Unplanned one-off large items of expenses. This may occur for instance as a result of a breakdown of a large piece of machinery
- poor credit management.
The significance and impact of each item will depend on a number of factors. Therefore losses may be sustained for a period depending on how large cash resources are whether in the form of positive bank balances or the availability of overdraft facilities. Inflating costs over inflating sales prices is not sustainable in the long-run. The significance of this may depend on the capability of the business to implement cost savings or to diversify markets where prices could be increased. Over trading is a trouble of forecasting and planning for adequate long-term capital. The idea is that growth must be within available resources. Seasonal trading requires careful cash management and the extent to which cash resources can be smoothed over the year. Unplanned main items of expenditure may be important if alternative sources of finance are not available such as leasing.