Strategies to Improve Cash Flow (DP IB Business Management)

Revision Note

Flashcards

The Relationship Between Investment, Profit & Cash Flow

  • Business investment involves the purchase of assets that are expected to create value over time

    • E.g the purchase of new machinery will improve productivity or quality which may allow the business to sell more items at a higher price and this increases sales revenue 

  • Financial investment may include the purchase of shares, bonds or property with the expectation that they will gain value over time

    • For some businesses this is an important source of income alongside their core business activities

      • E.g. US supermarket giant Walmart owns and leases over 10 thousand residential and commercial properties worldwide which act as as important added revenue stream for the brand 

  • Investment, profit and cash flow differ over the lifetime of a business

Diagram: cash flow and profit over time

The investment, profit and cashflow is different for businesses at different points of their journey, such as start ups, established businesses, and large/multinational businesses
Investment, profit and cash flow over the lifetime of a business

Strategies to Improve Cash Flow

  • The best way to improve cash flow is to manage the business better

    • Use cash flow forecasts to identify potential cash flow issues before they arise - and take appropriate action

    • Budget effectively and consider adopting zero budgeting to carefully control spending

    • Set clear financial objectives and look for ways to reduce outflows and increase inflows wherever possible

      • E.g. Global conglomerate 3M, maker of Post-it Notes announced in early 2023 that it intends to raise prices and cut about 6,000 jobs to improve its profits and cash flow position 

  • A business can also have too much cash

    • If a business is holding large amounts of cash it is likely to be missing out on the benefits of investing it in fixed assets or investments

    • This may represent a significant opportunity cost especially when interest rates are high

Methods to Improve Cash Flow

Method

Explanation

Reduce the credit period offered to customers

  • Collecting money owed from customers more quickly will increase the level of current assets in the business

    • However, customers may move to competing businesses that offer better credit terms

Ask suppliers for an extended repayment period e.g an extension from 60 to 90 days

  • Current liabilities will not be reduced

  • The business can use cash it would have paid to suppliers for other purposes

  • Suppliers may be unwilling to extend credit terms

Make use of overdraft facilities or short-term loans

  • Current liabilities will increase

  • The business can spend more money than it has in its bank account

  • Banks may be reluctant to lend to businesses with cash-flow problems

Sell off excess stock

  • Less liquid current assets will be reduced and converted into more liquid forms of current asset (e.g. cash)

  • Storage and security costs may also be reduced

  • Stock may need to be sold at a low price to attract sales

Sell assets and lease fixed assets instead (e.g. sale & leaseback

  • Both current assets and current liabilities will increase

  • The business will continue to have the use of assets but must make regular payments to the leasing company

Introduce new capital and reduce drawings from the business

  • Current assets will be increased

  • New capital may be introduced by the owner or from additional investors

  • This may result in the dilution of control of the business

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