Businesses that have cash flow problems must find a remedy to this in the short to medium term because without cash a business is unlikely to have a long-term future. Even the most profitable businesses will fail or become insolvent if they do not have cash because its cash and not profits that is used to pay creditors, to acquire assets, to pay employees, or to pay the shareholders for investing into the business.
Sources of Cash
Below are some of the sources that a business can use to get cash into the business or to improve cash flows if it is having some cash problems:
- A prudent business must always have a bank overdraft facility with its bank to ensure that it has cash available at short notice when it needs it. The business must use bank overdraft as cover for short term cash short falls. Bank overdrafts must not be used to fund fixed assets as this can lead to an asset liability mismatch. This can cause problems if the current liabilities are demanded at short notice which may not be sufficient for the business to dispose the fixed assets.
- The business must improve the way it manages its working capital. The business must implement credit controls that ensure that amount owed to debtors is paid when they are due. The business can also improve inventory management by not tying too much cash into stock. Creditors should not be paid early, rather, they should be paid when the payment is due.
- The business can also liquidate or sell investments it currently holds such as shares in other companies or investments held in money or capital markets. The business can also sell surplus assets or fixed assets that are not generating their return on equity.
- The business can reduce non-essential capital expenditure such as buying new cars or it can reduce the level of its investment in research and development. It is important to invest in research and development because it determines how competitive the business will be in the future. However, given the option of research and development or survival, the business should always chose to survive.
- Companies that have properties can sell and leaseback the property. This will release cash that was tied in the property so that the cash can be used to boost both the working capital and the long-term funding of the business.
- The business can use long-term borrowing such as bank loans, bonds, and debentures; however, the business should be aware that borrowing incurs borrowing fees and interest costs and that eventually the loans must be repaid. Long-term loans or long-term funding should be used to acquire fixed assets
- The business must reduce or not pay dividends to its shareholders. This may have short-term consequences such as a share price decline, but it is the better of two evils. It is better to see the share price fall than to let the business become insolvent.
- The business should raise additional capital from shareholders. It can do this by use of a rights issue or new shares float. Business should use this as one of its last options because it is expensive to issues new shares. The main advantage of raising new equity is that equity is not redeemable so it increases the permanent capital of the business.
Cash is king and it is vital to both the long-term survival and growth of a business. A business model that is not underpinned by sufficient cash resources is likely to end in failure. Unprofitable businesses with a lot of cash resources can still survive because they can pay creditors.
Managing the Capital Resources of a Business
Success in business is about marketing and selling the business’ inventory or growing the size of the business and entering into new markets. Success in business is also dependent on investing in the right investment opportunities, buying the right equipment at the right price and recruiting and putting the right people into the right jobs.
Investing in assets and recruiting staff resources require financial outlay. Therefore, if a business is to succeed it must recruit and inject capital resources into the business. The capital resources include inflows from the owners, undistributed profits and inflows from third parties such as banks, business angels, venture capitalists and other financiers. The cash injection can be in the form of either equity or loans.
All businesses whether they are established, social enterprises, small to medium enterprises or business start-ups have capital needs. Capital can be classified as:
- Fixed capital which is used to fund acquisition of capital expenditure or fixed assets
- Working capital to pay for routine and day to day or recurring expenditure such as inventory or stock and to finance the current assets of the business.
Fixed Capital
Fixed capital is the long term funding that a business uses to underpin its business strategy and business model. Fixed capital can be considered as the permanent capital of the business or the part of capital that does not fluctuate because of short term movements in current assets and current liabilities.
Fixed capital can be in the form of equity put into the business by the owners and it can also include long term loans such as loans from banks or lenders. Fixed capital should be used to finance the acquisitions of fixed assets such as buildings, plant, machinery and equipment.
Working capital
Working capital is the liquid capital of the business and is used to finance the routine or recurring expenditure of the business. Working capital is a variable form of capital and some businesses experience a high level of working capital volatility.
Working capital funds current assets such as inventory or stock, debtors and cash. If a business is to succeed in the long run it must manage its working capital effectively and efficiently. A business must have sufficient current assets to meet its obligations. Working capital management involves the management of all aspects of both current assets and current liabilities in order to mitigate the probability of insolvency or bankruptcy.
Businesses that are profitable or businesses that are increasing their sales revenue can still become insolvent if they do not manage working capital properly or if they do not have sufficient cash or liquid resources. This is so because business obligations and liabilities are settled by cash and not by profits.
The primary objective of working capital management is to ensure that sufficient cash is available to meet routine or day to day cash flow needs such as paying for staff wages and salaries, interest expenses, dividends to shareholders and meeting the amounts owed to creditors to ensure continued supplies of inventory. Managing working capital properly underpins both the strategic and tactical objectives, thereby ensuring the long term survival of the business.
Investing Capital
Success in business is dependent on investing capital; both fixed and working capital in the right investment opportunities, buying the right equipment at the right price and recruiting and putting the right people into the right jobs. Investing requires financial outlay therefore capital resources must be recruited. The capital sources include inflows from owners, accumulated profits or loans. Businesses have two forms of capital needs which are fixed capital assets and working capital.
