Loans from various financial institutions are often necessary for covering short-term cash flow problems
By: Nesa Rahmat
Revolving credit lines and equity loans are common types of credit used in this situation. Short-term cash flow problems can be fixed with borrowing as long as everything goes well.
However, if your business experiences a downturn in volume, short-term borrowing can cause a bank to call in a loan or cancel its credit line, leaving your business without adequate operating cash. Long-term loans amortized monthly can improve a business’s operating cash position. Amortized monthly means the monthly payment is constant and includes interest and principal portions that change in proportion as the loan is paid off.
During the early stages of the loan, the interest portion is high and the principal is low; however, this situation reverses itself over the life of the loan. In a situation in which long-term debt is used and the business has a seasonal peak demand, the excess cash should be invested in easily accessible, interest-bearing, low-risk accounts, such as savings accounts. The money should not be used for cash operating expenses or to avoid a shortfall when cash is needed. Keeping excess cash on hand reduces both the growth and the return on investment, and it is the best remedy for short-term cash flow problems.
The credit a company extends to its customers can be crucial in its impact on cash flow if the customers do not pay on time. New businesses and growing businesses often do not have the advantage of previous experience with their customers and can find themselves extending credit to high-risk customers.
Research should be done in advance to determine a customer’s ability to pay bills on time. Methods of determining this include obtaining a copy of a Dun & Bradstreet report on a potential customer and requiring potential customers to complete a credit application that asks questions about the business’s ability to pay. References should be checked to get others’ perceptions of customers and their integrity.
When working in a business activity that sells directly to customers, it is advisable not to extend store credit but to use charge cards. Information on offering credit card purchases can be obtained through your company’s bank. Banks charge businesses different rates for credit card sales, based on the dollar volume of the sales, so check several bank sources. The disadvantage of the credit card is it costs you a specified percentage, ranging from 2 to 5 percent, of the total dollar volume customers charge.
On the other hand, customers often expect the convenience of credit cards. As credit and terms are tightened, more customers will pay cash for their purchases, thereby increasing your cash on hand and reducing your potential for a bad debt expense. While tightened credit is helpful in the short run, it may not be advantageous in the long run. Looser credit allows customers more opportunity to purchase your products or services. Just be certain the increase in sales is greater than the increase in bad debt expenses.
Discounts for Early Payment
The practice of receiving cash discounts for early payment illustrates a major difference between the cash flow and projected income statements. Not taking advantage of a cash discount by paying bills promptly can improve your immediate cash flow, but can also negatively affect profitability. On the other hand, by paying early, your costs will be lower and profit margin higher, but your cash flow could be strained. Certainly a business should consider taking advantage of discounts, but should also know when and how to capitalize on them. Your company might also consider offering these discounts to help its cash flow.
Increasing sales appears to increase cash flow, but be careful. For many companies, a large portion of sales are purchased on credit. Therefore, when sales increase, accounts receivable, not cash, increase. Receivables are usually collected 30 days after the purchase date. Sales expenses are most often incurred before receivables are collected. When sales rise, inventory is depleted and must be replaced. Because receivables have not yet been collected, a substantial increase in sales can quickly deplete a firm’s cash reserves. With a computer, you can monitor this critical data and increase the time required to consider alternate what if scenarios.
When it comes to short-term cash flow problems, consumers have a variety of choices, ranging from credit cards to home equity loans.
Personal loans are used for various purposes, such as meeting family emergencies, purchasing home furnishings or consolidating other debts. These loans are generally short-term. Most personal loans range from $100 to $5,000 with the borrower paying equal installments at regular intervals over a determined number of weeks, months or years.
When deciding whether to obtain a personal loan to cover for your short-term cash flow problems, consider the benefits and responsibilities.
When you consider borrowing money know that a personal loan:
1. Obligates future income. You’ll be required to set aside a certain amount of future income for loan payments.
2. Requires discipline. Borrowing wisely means not borrowing more than you can handle. Don’t let the thrill of buying or having a sum of cash obligate you to more than you can afford.
3. Makes it possible to meet unexpected expenses. The ability to borrow and make affordable payments can be helpful if an emergency arises that requires extra money.
4. Allows you to obtain products and services now and pay for them later. A loan can provide an opportunity to purchase bigger-ticket items and use them right away.