Question

A friend who started a business during the last year has come to you with the following statement: "My accountant is preparing our first financial report and she told me one of the statements was a Statement of Cash Flows. She also told me that my business is facing cash flow problems."

Instructions
Prepare a reply to your friend. Include three causes of cash flow problems and solutions to solve the cash flow problems. Explain how the Statement of Cash Flows will assist in managing the business.

Answer 1

Include three causes of cash flow problems and solutions to solve the cash flow problems. Explain how the Statement of Cash Flows will assist in managing the business ?

Answer:

Examples of Cash Flow Problems & Solutions for that:

1. Not Immediately Realizable Invoices:

The invoices we raised are not immediately realized, this is one of the common cause for cash flow problems. As a business, you have to offer 30-day to 120-day payment terms to clients. However, small companies can’t always afford to wait this long for payment. They need money sooner. Eventually, slow payments create a financial problem that can seriously affect your business even if it’s growing quickly.

Solution:

One thing we can use is invoice factoring to finance slow-paying invoices. This method improves cash flow immediately and enables you to offer payment terms with confidence.

Another Solutions is to provide clients with an incentive to pay faster. Offering a 2% or 5% discount in exchange for a payment in 10 days can motivate clients to pay quickly. However, this incentive needs to be negotiated directly with each client.

1. Excess Bad Debts:

Bad debt affects the business cash flow and your profitability. Bad debt occurs when you sell product, or provide a service, to a client who does not pay.

Solution:

Provide terms only to clients who have good credit and a solid payment record. Others should prepay until they have built a track record with your company. The solution to this problem is to review the commercial credit of your clients before you extend payment terms. This strategy may cost you some sales. However, it will only cost you clients who were deemed credit risks to begin with.

1. Excess Inventory:

This problem can affect companies that manufacture goods or re-sellers that keep a warehouse stocked with products. If too much product is made or purchased, it ends up sitting on shelves and tying up cash flow.

Solution:

Companies that re-sell products can also use purchase order financing to finance large sales that exceed their cash flow capabilities. When used correctly, purchase order financing can improve your cash flow and allow you to finance the supplier expenses associated with large orders

The amount of product you keep in stock depends on your volume, sales forecasts, available cash, and supplier capabilities. Monitor inventory levels carefully. Having key products out of stock is a sure way to lose clients. Using methods like Reorder levels, inventory management software, etc.,

How cash flow will assist in managing the business?

Traditional financial statements comprised of a balance sheet portraying at the end of accounting period, resources controlled by the reporting enterprise together with sources of funds used for their acquisition and a statement of income, showing income, expenses and profit earned or loss incurred by the reporting enterprise during the accounting period. It was however noticed that due to use of accrual basis of accounting, recognition of financial elements, e.g. assets, liabilities, income, expenses and equity, coincide with the events to which they relate rather than with cash receipts or payments. For this reason, traditional financial statements fail to inform the users the way the reporting enterprise has generated cash and the way these were utilised during the accounting period. To a person, less accustomed with accounting practices, it may sometimes appear perplexing to observe that despite earning large profit, an enterprise is left with very little cash to pay dividends. The need for inclusion of a summary of cash receipts and payments in the financial statements of the reporting enterprise was therefore recognised. The summary of cash receipts and payments during an accounting period is called the Cash Flow Statement.

Effectively managing and monitoring cash flows serves many purposes. The most significant reason is to provide owners and managers insight into the company’s cash position. This knowledge better equips management to make informed decisions about regular business operations, the need for further investment in the business, and capital from equity or debt partners. Cash management is something most businesses of all sizes struggle to perfect. While the Cash Flow Statement is by no means the only method of monitoring cash flows, it is an integral part of the reporting statements and should not be overlooked by the financial statement users.