Improving Cash Flow

This lesson covers AQA A-Level Business topic 3.5.4 — methods of improving cash flow, the difficulties businesses face in managing cash, and practical strategies for maintaining a healthy cash position. You will learn how to analyse cash flow problems and recommend appropriate solutions in exam contexts.

---

Why Cash Flow Matters

Cash flow is the lifeblood of any business. A business can survive without profit in the short term — many start-ups operate at a loss for years — but a business that runs out of cash cannot pay its bills, its staff, or its suppliers. It will cease trading.

Key Principle: More businesses fail due to cash flow problems than due to lack of profitability. Managing cash flow effectively is therefore a critical management skill.

---

Methods of Improving Cash Flow

1. Improving Cash Inflows

Method	How It Works	Example
Reduce credit terms	Require customers to pay more quickly (e.g., 14 days instead of 30 days)	Changing payment terms from "Net 30" to "Net 14"
Offer early payment discounts	Incentivise faster payment (e.g., 2% discount if paid within 7 days)	"2/10 net 30" — 2% discount for payment within 10 days, otherwise full payment in 30 days
Improve credit control	Chase overdue invoices more aggressively; conduct credit checks on new customers	Hiring a credit controller; using automated reminder systems
Debt factoring	Sell trade receivables to a factor for immediate cash (at a discount)	Selling £100,000 of invoices to a factor for £95,000 cash
Increase prices	Higher prices generate more revenue per unit sold	Raising prices by 5% (if demand allows)
Increase sales volume	More sales generate more cash inflows	Marketing campaigns, expanding into new markets
Sale and leaseback	Sell a major asset (e.g., a building) and lease it back	Selling head office for £2m and paying £120,000 annual rent
Seek additional funding	Obtain a bank loan, overdraft, or equity investment	Securing a £500,000 overdraft facility

Worked Example: Early Payment Discount

A business currently offers 30-day credit terms. Its average monthly receivables are £200,000. It introduces a 2% discount for payment within 7 days.

If 60% of customers take the discount:

• Cash received earlier: 60% x £200,000 = £120,000 (within 7 days instead of 30 days)
• Cost of discount: 2% x £120,000 = £2,400 per month
• Benefit: £120,000 cash received 23 days earlier, improving cash flow and reducing overdraft costs.

The net benefit depends on whether the overdraft interest saved exceeds the £2,400 discount cost. If the overdraft rate is 8% per annum:

Interest saved = £120,000 x 8% x (23/365) = £604.38 per month

In this case, the discount costs more than the interest saved (£2,400 > £604), so it is only worthwhile if the improved cash flow provides other benefits (reduced risk, improved supplier relationships).

2. Reducing Cash Outflows