Cash-Flow Problems: Causes, Consequences and Solutions
A cash-flow problem occurs when a business does not have enough cash available to pay what it owes when it falls due, even if the business is otherwise profitable.
Method
- Identify the specific cause of the cash-flow problem in the scenario, e.g. late-paying customers, a sudden fall in seasonal demand, overtrading.
- Explain the consequence that follows from that cause, using detail from the scenario, e.g. unable to pay a specific supplier or wage bill on a specific date.
- Distinguish a cash-flow problem from a lack of profitability: a business can be profitable yet still run short of cash because of timing.
- Match a solution to the specific cause identified, rather than suggesting a generic fix, e.g. if the cause is late-paying customers, the solution should target collecting money owed faster, such as chasing debtors or offering an early-payment discount.
- Consider the cost or drawback of the proposed solution, e.g. an overdraft charges interest; chasing debtors too aggressively can damage customer relationships.
- For an evaluate-style question, weigh more than one possible solution against each other and reach a supported recommendation.
Worked example
A business's forecast shows a closing balance of -3,000 pounds at the end of March. Its outstanding customer invoices, money it is owed but has not yet received, total 5,000 pounds, of which 4,000 pounds is more than 60 days overdue. Suggest one solution to the cash-flow problem, and explain, using the figures, whether it is likely to be enough to fix the shortfall.
- Identify the shortfall: the closing balance is -3,000 pounds, so the business needs at least 3,000 pounds more in cash by the end of March.
- Identify a solution matched to the cause: the business is owed 5,000 pounds by customers, of which 4,000 pounds is overdue, so chasing these overdue invoices for payment is a solution directly matched to the cause of the shortfall.
- Compare the solution to the shortfall: even collecting just the 4,000 pounds overdue would be more than enough to cover the 3,000 pound shortfall, since 4,000 is greater than 3,000.
- State the conclusion: chasing the 4,000 pounds of overdue invoices is likely to be enough to fix the shortfall, provided the customers actually pay once chased, which is not guaranteed.
Practice questions
Try each question, then tap to reveal the answer.
Q1What is meant by a 'cash-flow problem'?Show answer
Answer: A situation where a business does not have enough cash available to pay what it owes when payment is due, even if it is profitable overall.
Q2What is overtrading?Show answer
Answer: Expanding sales or production faster than the business's cash resources can support, which can lead to a cash-flow problem even though sales are growing.
Q3Give one consequence a business could face if it runs out of cash to pay its suppliers.Show answer
Answer: Suppliers may refuse to supply goods on credit in future, demand payment upfront, or take legal action to recover the debt, and relationships with the supplier could be damaged.
Q4Give one solution a business could use if late-paying customers are causing its cash-flow problem.Show answer
Answer: Chase overdue customer payments more actively, offer a discount for early payment, or reduce the amount of credit, the time to pay, it offers to customers.
Q5Give one solution a business could use for a short-term cash-flow shortfall, other than chasing customer payments.Show answer
Answer: Arrange or extend an overdraft, delay a non-essential purchase, or negotiate longer payment terms with its own suppliers.
Q6Why can a profitable business still become insolvent?Show answer
Answer: Because profit and cash are not the same thing; if the business's cash is tied up, e.g. in unpaid customer invoices or stock, it may not have enough cash available to pay its debts as they fall due, forcing it to close even though it is profitable on paper.
Q7State one drawback of using an overdraft to solve a cash-flow problem.Show answer
Answer: The business is charged interest on the amount borrowed, which is often at a higher rate than a standard loan, adding to its costs.
Exam-style questions
Written in the style of a GCSE Business exam paper, with a full mark scheme.
A business's cash-flow forecast shows an opening balance for August of 1,800 pounds, forecast inflows of 6,200 pounds, and forecast outflows of 9,500 pounds. (a) Calculate August's net cash flow. (2 marks) (b) Calculate August's closing balance. (2 marks) (c) The business decides to arrange an overdraft to cover the shortfall shown by the closing balance. State the minimum overdraft limit it would need to cover this shortfall. (2 marks)
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A growing online clothing business has seen sales double in the last six months, but is now struggling to pay its suppliers on time because most of its cash is tied up in stock and in payments still owed by business customers who buy on 60-day credit terms. Evaluate two possible solutions the business could use to solve this cash-flow problem.
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See real GCSE Business past-paper questions, with official mark schemes →
Free printable worksheet
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