UNIT 5 - CHAPTER 19 - IMPROVING CASH FLOW AND PROFITS

CAUSES OF CASH FLOW PROBLEMS >>3. POOR CREDIT CONTROL

- a business's credit control department ensures that customers keep to agreed borrowing limits and pay on time. -if this aspect of a businesss's operations becomes inefficient, cash inflows into the firm can be delayed. -in some cases a customer may not pay at all (known as a 'bad debt'). -in such circumstances it is highly likely that a firm will encounter problems with its cash flow.

IMPROVING PROFITS -there are a number of methods that a business can use to achieve aim of increasing profits, these include... >>2. INCREASE PRICES

-NORTHERN RAIL introduced changes to its pricing structure in SEP 2014 that resulted in some fares during the evening period rising substantially. -the decision resulted in claims that ticket prices could double. -the company has received adverse publicity and the impact of change on passenger numbers remains to be seen.

IMPROVING PROFITS -there are a number of methods that a business can use to achieve aim of increasing profits, these include... >>7. ELIMINATING UNPROFITABLE ASPECTS OF PRODUCTION

-a business can take decisions to close down certain aspects of its operations that are making a loss. -this can lead to increased profits for the remaining parts of the enterprise as the business uses its resources in the most efficient manner. -LA SENZA a lingerie retailer, revealed in JULY 2014 that it is to close 12 stores with the loss of 130 jobs as it seeks to improve its profitability.

IMPROVING PROFITS -there are a number of methods that a business can use to achieve aim of increasing profits, these include... >>4. USE CAPACITY MORE FULLY

-a business's capacity is the max it can produce. -if this capacity is used fully then the business's fixed costs are spread across more units of output, helping to reduce average cost. -if prices are unchanged, profits should rise as the business's profit margin per unit will rise. -at the same time, more of the business's products are sold without incurring too many additional costs. this should increase revenue and profits.

IMPROVING PROFITS -there are a number of methods that a business can use to achieve aim of increasing profits, these include... >>3. IMPROVE BUSINESS'S EFFICIENCY

-an efficient business uses minimal amount of resources to produce its goods or services. -managers can take a number of decisions to increase the efficiency of their business and thereby reducing costs, with positive implications for profits.

CASH FLOW AND BUSINESS PERFORMANCE -a business can benefit in a number of ways from effective and careful management of cash flow... >>2. GOOD RELATIONS WITH SUPPLIERS

-careful management of cash makes it more likely that a business will be able to pay suppliers promptly and in full. -many suppliers offer discounts for prompt payment and this can help a business to reduce its costs. -receiving a discount on supplies also is a effective way of reducing the business's costs.

IMPROVING PROFITS -there are a number of methods that a business can use to achieve aim of increasing profits, these include... >>6. IMPROVE METHODS OF PRODUCTION

-decisions to improve efficiency of production process can help to reduce costs and to improve profitability. -on the island of JERSEY, a number of businesses have been encouraged by the island's gov to recycle cooking oil for use to fuel vehicles. -this helps to reduce disposal costs of the oil, as well as reducing expenditure on petrol or diesel.

DIFFICULTIES IN IMPROVING CASH FLOW AND PROFIT -managers can face a number of diffs when attempting to improve a business's performance in terms of cash flow and profits...

-identifying that there is a problem. -researching the cause of problem -coping with any adverse consequences in terms of business image -some decisions may have adverse consequences in short term.

IMPROVING PROFITS -there are a number of methods that a business can use to achieve aim of increasing profits, these include... >>5. REDUCE NUMBER OF SUBSTANDARD PRODUCTS

-if a business produces products that are not of the right quality, then it incurs additional costs. -this is because it has paid to produce goods that it cannot sell. -these must either be scrapped or reworked to make them saleable. -in either case, costs rise. any management decisions, (e.g. training employees to monitor quality) that help to reduce the number of poor quality products will help to reduce costs of production and enhance profitability.

IMPROVING PROFITS -there are a number of methods that a business can use to achieve aim of increasing profits, these include... >>REDUCE COSTS OF PRODUCTION

-in 2014, HEINEKEN one of uks best known brewers announced that it was moving some of its operations from SCOTLAND to POLAND with the loss of 93 jobs. -the company will be able to take advantage of substantially lower wage rats in POLAND. -however these job losses have resulted in some adverse publicity for the company.

IMPROVING PROFITS -there are a number of methods that a business can use to achieve aim of increasing profits, these include... >>4. USE CAPACITY MORE FULLY

-many small uk airlines operate JETSTREAM 41 AIRCRAFT, which can hold a max of 29 passengers. -profits from operating these aircraft can be increased if the aircraft is full on flights. -in this context a full aircraft means that the airline is using its capacity as fully as possible. -the costs of operating a full aircraft are only a little higher (some additional fuel and meals) and more passenger fares will increase revenue.

IMPORTANCE OF MONITORING CASH FLOW managers need to assess the significance of any unexpected figures when analysing forecast and actual cash figures. -there are a number of poss causes when considering cash variances...

-may be a one - off occurrence that will not happen again - such as a cancelled order (or an unexpectedly large one) -could be due to seasonal variations such as high levels of sales at xmas or over summer period - can be important for certain types of businesses such as toy shops or garden centres. -more critically, may be part of continuing trend, whether sales are rising or falling steadily there will be cash implications. -could be self correcting - a surge in demand followed by a slump, and in this case no action will be required.

METHODS IN IMPROVING CASH FLOW >>2. NEGOTIATE IMPROVED TERMS FOR TRADE CREDIT

-most firms receive some trade credit from their suppliers. -this means that they are given 30 or 60 days to pay for supplies. -if a business can persuade suppliers who have previously been reluctant to offer trade credit to do so, it will improve its cash position. -remember, delaying payments always helps. -another important move might be to extend existing trade credit agreements from say, 30 to 60 days or from 60 to 90 days.

IMPROVING PROFITS -there are a number of methods that a business can use to achieve aim of increasing profits, these include... >>REDUCE COSTS OF PRODUCTION

-perhaps the 1st consideration of many managers when considering how to increase profits. -if a business can maintain its prices while reducing its costs of production then profit margins will increase. -so long as sales do not decline, its profits will rise. -however there are a number of risks in taking this action. 1st reduction in costs may result in lower quality goods or services being supplied. this could result in a loss of customers, which could prove counterproductive, and ultimately reduce profits.

METHODS IN IMPROVING CASH FLOW >>3.OFFER LESS TRADE CREDIT

-similarly a business can help its cash flow position by offering its customers less favourable terms for trade credit. -this may require all customers to pay for products within 30 days, whereas in the past trade credit was 60 days -however this decision may result in loss of customers as they move to competitors who offer more favourable credit terms.

METHODS IN IMPROVING CASH FLOW >>4. DEBT FACTORING

-the financial institution then organises the payment of the invoice and makes a further payment to the business concerned. -it is usual for the financial institution to retain about 5% of the value of the invoice to cover their costs.

METHODS IN IMPROVING CASH FLOW >>5. ARRANGE SHORT TERM BORROWING

-the majority of businesses have an agreed overdraft with their bankers, although small and medium sized enterprises (SME'S) in the uk have faced problems in negotiating overdrafts over the last few years. -an overdraft allows a business to borrow up to an agreed limit. -overdrafts can be expensive, but are reasonably economical and flexible when a business only borrows a set amount for a short period. -as an alternative, a business may decide on a short term loan to provide an injection of cash into the business. -a short term loan is likely to have a lower rate of interest and the option to pay the loan back over 2 yrs or so may be attractive to a business that is short of cash.

IMPROVING PROFITS -there are a number of methods that a business can use to achieve aim of increasing profits, these include... >>2. INCREASE PRICES

-the success of this decision depends on the importance of price in the decision to purchase and thus on price elasticity of demand. -the manager of a luxury hotel may be able to increase prices for accommodation and food with little effect on sales. -in contrast a small city centre cafe may find a high proportion of its customers move elsewhere if prices are raised.

METHODS IN IMPROVING CASH FLOW >>6. SALE AND LEASEBACK

-this method of improving cash flow has been widely used by businesses over recent yrs. it entails a business selling a major asset (e.g a building and then leasing it from the new owner). -this provides a significant inflow of cash into the business, improving the cash position, but commits the firm to regular payments to lease the asset. -in 2014, the BANNATYNE GROUP announced an agreement with M&G INVESTMENTS for the sale and leaseback of 39 of the company's health clubs. -this allowed the BANNATYNE GROUP to repay some loans and strengthen its cash position.

METHODS IN IMPROVING CASH FLOW -identifying potential cash flow problems is only part of the solution. -managers have to decide what actions to take to improve the cash position of their business. -a number of techniques can be used to improve cash flow, these include...

1. IMPROVED CONTROL OF WORKING CAPITAL 2. NEGOTIATE IMPROVED TERMS FOR TRADE CREDIT 3.OFFER LESS TRADE CREDIT 4. DEBT FACTORING 5. ARRANGE SHORT TERM BORROWING 6. SALE AND LEASEBACK

CAUSES OF CASH FLOW PROBLEMS -a number of other factors can contribute to cash flow difficulties...

1. OVERTRADING 2. ALLOWING TOO MUCH TRADE CREDIT 3. POOR CREDIT CONTROL 4. INACCURATE CASH FLOW FORECASTING

IMPROVING PROFITS -there are a number of methods that a business can use to achieve aim of increasing profits, these include...

1. REDUCE COSTS OF PRODUCTION 2. INCREASE PRICES 3. IMPROVE THE BUSINESS'S EFFICIENCY 4. USE CAPACITY MORE FULLY 5. REDUCE NUMBER OF SUBSTANDARD PRODUCTS 6. IMPROVE METHODS OF PRODUCTION 7. ELIMINATING UNPROFITABLE ASPECTS OF PRODUCTION

CASH FLOW AND BUSINESS PERFORMANCE -a business can benefit in a number of ways from effective and careful management of cash flow...

1. REDUCED BORROWING COSTS 2. GOOD RELATIONS WITH SUPPLIERS 3. PUBLIC RELATIONS

DIFFICULTIES IN IMPROVING CASH FLOW AND PROFIT >>SOME DECISIONS MAY HAVE ADVERSE CONSEQUENCES IN THE SHORT TERM

a business may decide to invest more heavily in advertising to boost sales and improve profits. -however in the short term the increased cost of promotion may damage its profits until sales begin to rise.

PROFITABILITY

a measure of financial performance that compares a business's profits to some other factors such as revenue.

CASH FLOW AND BUSINESS PERFORMANCE -a business can benefit in a number of ways from effective and careful management of cash flow... >>3. PUBLIC RELATIONS

businesses experiencing cash problems may lose the confidence of their customers, who doubt their ability to continue to supply goods and services. -in such circumstances customers may no longer place orders; this is almost certain to exacerbate the problem and may result in the company being unable to continue trading.

METHODS IN IMPROVING CASH FLOW >>4. DEBT FACTORING

debt factoring is a service offered by banks and other financial institutions. -if businesses have sent out bills (also termed invoices) that have not yet been paid they can 'sell' these bills to gain cash immediately. -factoring debts in this way provides up to 80% of value of an invoice as an immediate cash advance.

METHODS IN IMPROVING CASH FLOW >>4. DEBT FACTORING

debt factoring is generally used by small businesses. -businesses with a turnover above £1 million normally use an alternative technique (called invoice discounting) where the company retains the administration deal within the business. -this way, its customers need not know that the company is using a debt factoring service. -this can help a business retain the confidence of its customers.

DIFFICULTIES IN IMPROVING CASH FLOW AND PROFIT >>RESEARCHING POSS CAUSE OF PROBLEM

identifying that there is a problem is the first difficulty. -in many cases the management team will have to research the cause before being able to take appropriate action. -if a company suffers a large and sudden fall in sales and thus profit it may have to invest in primary market research to discover the reasons for the decline in consumer interest. -this may be a rival offering similar products more cheaply or may be because its products are considered unfashionable. -once the cause is known suitable remedial action can be taken.

CASH FLOW AND BUSINESS PERFORMANCE -a business can benefit in a number of ways from effective and careful management of cash flow... >>1. REDUCED BORROWING COSTS

if managers can predict periods of cash flow difficulty and take appropriate actions, then it is likely that a business will not need to use its overdraft facility as fully as might have been the case. -this can reduce interest charges significantly. -if a business exceeds its overdraft limit then its bank is likely to impose penalty charges. -reducing interest charges means that the business will incur lower costs and enjoy higher profits.

CAUSES OF CASH FLOW PROBLEMS >>4. INACCURATE CASH FLOW FORECASTING

it is unlikely that managers will always forecast cash flow accurately. -inaccurate forecasting can lead to a business not believing that it will face cash flow problems and possibly not monitoring its forecasts to confirm that they are correct. -inaccurate forecasting may occur because of inexperience on the part of managers, unexpected costs, perhaps due to an unforeseen rise in the price of fuel or raw mats or simply over optimistic assumptions about the level of future revenue from sales.

DIFFICULTIES IN IMPROVING CASH FLOW AND PROFIT -in addition each method we have discussed to improve a business's cash flow or profits and profitability has particular diffs associated with..

it.

METHODS IN IMPROVING CASH FLOW >>4. DEBT FACTORING

many firms believe that to lose up to 5% of their earnings means that factoring is uneconomic. (it can eliminate much of their profit margin). -however factoring does offer the benefit that the immediate cash provided by the factor means that the firm is likely to have lower overdraft requirements and will pay less interest.

PROFIT

measures extent to which revenues from selling a product over some period exceed the costs incurred in producing it.

CAUSES OF CASH FLOW PROBLEMS >>2. ALLOWING TOO MUCH TRADE CREDIT

most businesses offer trade credit, allowing customers between 30 - 90 days to pay. -this helps to win and retain customers, however if a firms trade credit policy is too generous, it may lead to cash flow difficulties as cash inflows are delayed. -in such a situation a business may find itself unable to pay its bills when they are due as it has not received payment from its customers.

CAUSES OF CASH FLOW PROBLEMS >>1.OVERTRADING

occurs when a business expands quickly without organising funds to finance the expansion. -rapid growth normally involves paying for labour and raw mats several months before receiving payment for the final product. -if this occurs over a prolonged period, a business can face severe cash flow shortages.

TRADE CREDIT

offered when purchasers are allowed a period of time (frequently 30,60 or 90 days) to pay for products they have bought.

IMPORTANCE OF MONITORING CASH FLOW -in chapter 17 we saw that managers at MARSHALL BOOKS LTD has drawn up a cash flow forecast as part of their financial planning for the...

opening of the company's newest book shop. -it is apparent (from data in textbook) that the bookshop's cash position is slightly worse than forecast. -the mangers expected to have a closing balance of (-£11,750) whereas it is (-£12,620). -this means they may need to increase the overdraft above the amount they originally thought would be needed.

TAKING ACTIONS TO IMPROVE PROFITABILITY -not all actions intended to increase profits will increase profitability and vice versa. -e.g. a decision to increase prices is likely to increase a business's profitability as it will probably result in a higher % of the selling price of a product being..

profit. -however if demand is price elastic it may result in a fall in overall profits.

TAKING ACTIONS TO IMPROVE PROFITABILITY -we saw earlier that NORTHERN RAIL has increased its early evening fares substantially. -this action is likely to increase its profitability. -the company will probably enjoy increased...

profits as well as profitability from this price rise as it does not face any direct competition and therefore demand for its services is likely to be price inelastic.

IMPROVING CASH FLOW -first stage in improving a business's cash flow is to identify why the business is encountering difficulties in this area. -having identified the cause of the problem it is possible to apply the most appropriate..

remedy.

IMPROVING PROFITS AND PROFITABILITY -a business can improve its profits if it reduces its costs or increases its revenues without any other changes occurring. -however increasing profitability requires managers to increase the amount of profit compared to some other measure such as ...

revenue. (we looked at the topic of profitability and profit margins in detail in chapter 17).

DIFFICULTIES IN IMPROVING CASH FLOW AND PROFIT >>COPING WITH ADVERSE CONSEQUENCES (IMAGE)

some decisions to improve cash flow or profits can have undesirable consequences. -HEINEKEN's decision to move some operations from SCOTLAND to POLAND has resulted in the loss of nearly 100 jobs (93). -this is likely to have harmed the comps image, especially in the area where the redundancies occur.

IMPORTANCE OF MONITORING CASH FLOW -if a manager can spot a looming cash flow problem at an early stage by comparing forecast and actual cash flow on a monthly basis then it is possible to..

take prompt and decisive action. -these actions may rectify the problem before it becomes too severe.

IMPROVING PROFITS -a survey by THE ROYAL BANK OF SCOTLAND revealed that over 25% of small businesses said...

that increasing their profits was their 'main objective'.

CASH FLOW

the movement of cash into and out of a business over a time period

IMPROVING PROFITS -there are a number of methods that a business can use to achieve aim of increasing profits, these include... >>2. INCREASE PRICES

the other obvious option is to increase price at which the business sells its products. an increase in revenue per unit with costs stable will boost profit margins. -however this is a risky option as an increase in price may lead to existing customers to seek alternative suppliers (if demand is price elastic). and also potential new customers looking elsewhere.

TAKING ACTIONS TO IMPROVE PROFITABILITY -most actions intended to cut costs have the potential to increase profits and profitability so long as the action does not reduce the value the consumer receives from..

the product. -so actions to reduce a company's waste should increase profits and profitability as they are unlikely to have adverse consequences for consumers.

DIFFICULTIES IN IMPROVING CASH FLOW AND PROFIT >>IDENTIFYING THERE IS A PROBLEM

this is not always simple to do in a timely fashion. -may take a business several months to uncover a cash flow problem, e.g. especially if cash budgets are not carefully monitored.

CAUSES OF CASH FLOW PROBLEMS -arguably the major cause of cash flow problems is lack of planning by managers. -many businesses, once established, do not forecast in this way and are thus at risk of..

unforeseen problems.

IMPORTANCE OF MONITORING CASH FLOW -monitoring cash flow is an essential and on going element of managing cash flow effectively and on improving a poor position. -the process of comparing actual and forecast cash flows is called...

variance analysis. -can have adverse or favourable variances.

METHODS IN IMPROVING CASH FLOW >>1.IMPROVED CONTROL OF WORKING CAPITAL

working capital is the finance available to the business for its day to day trading activities. -working capital is available to businesses when its customers pay for its products they have received. -working capital is used to pay wages, and for fuel and raw materials. -there are a number of techniques set out below that a business may use to improve its working capital.