A Business Can Be Profitable But Still Run Out of Cash
- If a company spends too much, doesn’t get paid on time, or fails to plan properly, it can end up struggling to pay the bills, even if it’s making money on paper.
- To avoid this, businesses need to cut unnecessary costs, speed up incoming cash, and find backup funding when needed.
Hint
Profit is an accounting measure, while cash flow is about real money in the bank.
Reducing Cash Outflows
- Negotiate better payment terms. Asking suppliers for longer payment terms gives businesses more time to collect cash before making payments.
- Delay major purchases. Holding off on expensive equipment or upgrades helps preserve cash, unless the delay impacts efficiency.
- Cut non-essential expenses. Reducing discretionary spending such as unnecessary software or excessive marketing, keeps more cash available for critical needs.
- Find lower-cost suppliers. Switching to more affordable materials or renegotiating contracts can reduce cash outflows without sacrificing quality.
Example
If your supplier agrees to 60-day terms instead of 30, you gain more time to collect cash from customers.
Example
A restaurant that switches to a more affordable supplier for packaging can lower costs without affecting food quality.
Increasing Cash Inflows
- Encourage upfront payments. Requiring deposits or full payment at the time of purchase speeds up cash collection.
- Offer early payment discounts. Small discounts incentivize customers to pay sooner, improving cash flow.
- Tighten credit terms. Reducing the time customers have to pay prevents cash from being tied up in unpaid invoices.
- Expand revenue streams. Launching new products or entering new markets can bring in additional cash, but requires careful planning.
Note
A business that relies too heavily on credit sales risks running into cash shortages if customers delay payments.
Securing Additional Cash
- Sell unused assets. Selling old equipment or excess inventory can provide quick cash without taking on debt.
- Use an overdraft. A short-term bank overdraft can cover temporary cash gaps but comes with high interest costs.
- Try sale and leaseback. Selling an asset and leasing it back frees up cash while allowing continued use, though it increases long-term costs.
Example
A logistics company might sell a warehouse for immediate cash but lease it back to maintain operations.
Theory of Knowledge
To what extent do financial strategies for managing cash-flow problems rely on objective data versus subjective decision-making?
