Problems with cash flow
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This document summarizes potential solutions to cash flow problems being experienced by a business called Lewis Appleton. Two main solutions are proposed: 1) Increasing advertising spending from £500 to £1000 per month to potentially increase sales by 50% and generate an extra £10,000 profit each month, though there is risk that sales may not increase. 2) Having the business owner take a reduced monthly draw of £2000 instead of £3000 so that the business reaches a positive cash flow sooner and has more money to reinvest in growth. However, this could mean the owner has to live on less personally. The advantages and disadvantages of each solution are discussed.
Problems with cash flow
- 1. Unit 5 M1 Lewis Appleton Mr McColgan Cash flow problems One of the problemsisthatitactuallytakesa while tostart makinga profitwithinthe business;one of the reasonsforthismay be because of the £3,000 drawingstakeneachmonth.It takes10 months to getout of the negative balance whichisalongtime,howevertheyare thenmakingahighprofit so it’spossible totake more drawingsorspendmore onthe business.If theywere totake only £1,000 a monthforthe firstyearthenthe businesswillhave apositive balanceafteronly5months whichishalf the time. Advertisingappearstobe a problem;the reasonforthisisit isunpredictable.If the moneyspenton advertisingwastoincrease to£1,000 theirsalesmaydouble but it’salsopossiblethatthere would not be a cost efficientdifference,the same applieswhenreducingthe moneyspentonadvertising.If doublingthe advertisingmoney,suppliesanddrawings,the businesswilltake 8monthsto have a positive budget,andafterone yeartheywill be £30,000 positive balance,butthisisnotguaranteed to happenthisway. Howeverthe problemwiththisisthatbytakingthe £36,000 yearlydrawings,for the firstyear he isonlyprofiting£16,000 because he deposited£20,000 capital of hisownmoney intothe businessatthe start. The advertisingisafixedcostmeaningithasto be paidfora setamount;if theydidn’tpayit then theywouldnot make as much moneyastheycould.The rent hasto be paidso thisisone of the mostimportantfixedcosts;the businessneedstomake sure thattheypaythisoff each monthso that theyare able tooperate. Anotherproblemisthatthe original closingbalance isnegative,anditcontinuestogetworse.It takesa while togetout of the negative andthere isone pointwhere theyhave almost£16,000 debt. At thispointif somethingwastohappentothe businesssuchasbeingunable tokeepupwithcosts, the debtwouldhave tobe paidoff by the owner.Anotherproblemisthatmanybig costswere made injust the firstmonth, the £10,000 van may nothave actuallybeenneededforthe firstfew months, it couldhave beenpurchasedafewmonthslateror a cheapervancouldhave beenpurchased. Anotherproblemisthatthe salesare not guaranteedandinFebruaryhe spentmore on supplies than he had receivedasincome fromthe salesforthe month.The change inadvertisingis noticeable,althoughthe businessis £300 betteroff eachmonth,inJune and Julytheywere earning £22,000 insaleswhereasafterthe advertisinghaddecreasedforafew monthstheywere earning £22,000 whichmeanstheymayhave beenbetteroff payingthe extra£300 a month.
- 2. Unit 5 D1 Lewis Appleton Mr McColgan Possible solutions Solutionone Firstof all,the businesscouldspendmore onadvertising;the reasonfordoingthisisthat there isa visible difference whenthe costschanged.Inthe monthjustbefore andafterthe costof advertising was reducedfrom£500 to £200 there were salestotalling£22,000 a month,the followingmonththe saleswere only£18,000 and at the endof the year theymanagedtogo back up to £20,000. Therefore itisvisiblethatthe £300 reductionhada £4,000 difference insales.Thereforeincreasing the advertisingto£1,000 may allowthe businesstohave salesof £30,000. Althoughtheywill be spendinganother£800 each monththeycouldmake another£10,000. Advantages The advantagesof doingthisare that theycan make 50% more than theyusually do,eventhoughit isnot guaranteedithas alreadybeenseenthatthe advertisinghasalarge effectonthe salesand therefore itisat leastworthtryingfora few months.Thisisalsogoodbecause theydonot have to keepthe price of advertisingupandif itdoesnot workas well astheywant itto, the price can be reducedagain.Evenif theymake a small lossbyadvertisingforthe higherprice the brandawareness will be increasedandtherefore the advertisingcouldstill have the effectonsalesfora few months aftertheyreduce the amountagain,thismeansthat theycouldstill make aprofit. Disadvantages The disadvantagesare thatalthoughitmay soundthat theyare goingto make another£10,000 profit,itdoesnotmeantheywill.A 50% increase insalesalsomeansa 50% increase inmoneyspent on supplies,therefore if theyusuallyspend£12,000 onsuppliesbeforethe increase,theywill then needtospendan extra£6,000 on supplies.£10,000 - £6,000 - £1,000 = £3,000. Therefore theyare actuallyonlygoingto potentiallybe £3,000 betteroff eachmonth insteadof the £10,000. Another disadvantage isthatthe resultsare not guaranteedandif the saleswere tonotchange thenthey wouldbe £800 worse off eachmonth. Solutiontwo The secondsolutionisthatthe ownerof the businesscouldtake lessmoneyforthe drawings,if they were totake only£2,000 eachmonthinsteadof £3,000 theywouldonlyhave towaituntil Julyto have a positive balance,theywouldbe personallyearning£24,000 for the firstyear althoughitis actually£4,000 aftertakingawaythe capital investedinthe business.Howeverthe businesswould actuallyhave a £15,000 positive balance atthe endof the yearwhichmeanstheycan thenstart to take more drawings,or putmore moneyback intothe businesssuchasadvertisingora new and bettervancouldbe purchased. Advantages The advantagesof doingthisare that the businesswouldbe inapositive budgetmuchearlierand therefore if anythingwastogowrong the debtto paywouldnotbe as high.There isalsothenmore
- 3. Unit 5 D1 Lewis Appleton Mr McColgan potential tospendthe moneybackintothe businesssuchasincreasingthe advertisingwhichwould increase the chance of makinga higherprofitandthiscouldactuallybe usedwiththe firstsolution. The moneyleftovercan alsobe spenton gettingbettertransportsuchas a van that useslessfuel and has cheaperinsurance asalthoughthere wouldbe ahighercostat first,the moneysavedinthe longtermwouldadd upand keepsthe businessspendingless moneysomore income canbe generated. Disadvantages The disadvantagesof doingthisare that the owneractuallyneedsthe moneyfortheirownpersonal livingcostsandtherefore theywouldhave tospendlesspersonallytobe able todothis.Thismay meanthat theyhave to spendlessonluxuriesthattheywouldlike doing.Anotherdisadvantage is that by puttingthe moneybackintothe businesstheymaybe spendingmore thantheyactually needto.It alsohas to be consideredthattheirownlivingcosts mayinclude rent,electricity,heating and otherimportantthingsthatcannot be unpaid.Therefore itmaymeanthattheyare notactually able to take lessmoneyastheyare onlytakingwhattheyrequire.