Monday, January 27, 2014

Liquidity Problems

Cash Flow: liquidity problems and how to solve them!

Objective: to know different reasons for liquidity problems.

There are many reasons for liquidity problems (i.e. the problems associated with not having enough liquid assets, or cash).  These include;

1. Overtrading – a feature of new, rapidly growing businesses, this involves the attempt to fund large volumes of production with inadequate working capital.

2. Investing too much in fixed assets – fairly new businesses may be better to lease fixed assets so that resources/working capital is not drained.

3. Stockpiling – holding stocks of finished goods and raw materials is expensive.  Money tied up in this way is unproductive.  Stock control is an important aspect of business.

4. Allowing too much credit – failure to control debtors may lead to ‘bad debts’.  However, important to maintain good relationships with customers.

5. Taking too much credit – this can help cash flow, but there are drawbacks.  Credit might mean higher prices, fewer discounts, bad name in the trade.

6. Overborrowing – can threaten the ownership of the company.  Growth needs to be funded in a balanced way, for instance by using capital from share issues.

7. Underestimating inflation – inflation causes costs to rise.  Currently 2.9%.  Periods of high inflation are accompanied by high interest rates which puts further pressure on costs.

8. Unforeseen expenditure – provision must be made for the unexpected.  Equipment breakdowns, taxes falling due, workers strike, etc.
9. Unexpected changes in demand – fashion, health scares (beef).  Recession can get in the way – people reduce spending.  This can affect some markets more than others.

10. Seasonal factors – Christmas card manufacturers!  Needs careful management.

11. Poor financial management – weak understanding of the working capital cycle (the lags in the system of payment)

Solutions to a liquidity crisis…

Stimulate sales for cash
Sell off stocks of raw materials
Sell off fixed assets and lease them back
Chase up overdue accounts
Sell debt to a factoring company
Only make essential purchases
Extend credit with selected suppliers
Reduce personal drawings from the business
Negotiate additional short term loans.

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