The length of the business cycle is a combination of:
The length of the production process, which on the product. A service industry such as a restaurant has a very short production time. To construct a road bridge takes a little longer. This means that if the business takes long with their products, then it would take them long to gain money off their customers, which would take long for them to pay off their suppliers. On the other hand it would much better for the restaurant as they are able to make quick production for their customers can gain money straight away as the customers would pay them straight away. This is good as the restaurant is able to pay off their suppliers having also been able to manage their working capital. The times taken to get the product to the market, for example overseas markets have a longer distribution process. Seasonal products may be manufactured but not delivered for many months. This also means that the longer the delivery of the product, the long it would take the business to sell thief products and make money, and also pay off money for business needs.
The credit given to purchasers
This depends on market conditions. As a general rule business customers expect longer credit than private customers. A retail business receives payments sooner than a manufacturer or wholesaler as the customers would purchase their [products straight away in the shop, on the other manufacturer and wholesalers would have to wait for a while before they crevice their payments as they would be selling a quantity of products to their retail customers. The relationship between firms also affects the credit period. A large, important customer may demand longer credit as they would be purchasing large quantity of products, so they would need time to pay it all back. A sole supplier can insist on early payment as they would be selling small quantity of products.
The credit given for purchases of materials or stock
Most businesses obtain credit for their purchases. The length of time allowed before payment depends on, how established the firm is (an established firm can negotiate longer credit than a new firm) as they are loyal customers to the suppliers and normally order large quantity of products to their suppliers. This would let the suppliers give the established firm a longer period of payment as they trust them as they are a well known firm and loyal to them giving them an opportunity of paying later. Its credit record (a firm with a good record of paying can negotiate longer credit) as they supplier can trust them defiantly buy the way they manage their working capital and also pay off their money straight to their suppliers can also negotiate with suppliers in paying off later. As the suppliers would trust them by the record of payments they have done, giving then confidence in giving them a longer amount of paying back their debts. Its credit worthiness (a firm that appears solvent can obtain longer credit than a firm that is struggling) meaning that the supplier can trust the business firm as they already know that the business can pay them back their money as they are known for their wealthy ness, so the suppliers know they are guaranteed payment, which is why they can give them a longer period of time.
For this, if the business was to sort out their timing and amount, then they would be able to manage their working capital properly as they would be taking it into account. It also needs to include an allowance for uncertainty, an extra 10% on to the expected cash requirement would usually be sufficient. For a new small firm such as a new restaurant, though, a bigger safety net can be wise. It can take months for word to spread sufficiently to push the business above its break-even point.
Also the size of the order, as the larger the order is, the longer the business may get for credit as they would have a longer period of time of paying the suppliers back as they money would be large. Also regular order would give the firms credit than occasional customers as they would be known as loyal customers, so it would be very important for the supplier to make sure that the regular customers are happy, and by this, they give them a longer period of time to pay them back.
How can a business manage its working capital?
Maintaining good liquidity in a business is about managing the elements of the liquidity cycle. There are several ways that the business can minimise its working capital needs. These are centred on:
Controlling cash as it is very important that businesses obtain maximum possible credit for purchases. Also stop any delays of payment from the customers, as the longer the supplier gives the debtors time to pay off their money, the more problems it may bring to the working capital. It is very important that business control all the money that is coming in and out of the business in order to maximize and manager the working capital.
Getting goods to the market in shortest possible time - the sooner goods reach the customer the sooner payment is received. As if a business was to receive their goods late, then they would be selling anything to their customers then they wouldn’t make any money and then they wouldn’t be managing their capital properly as they would have no money. So Production and Distribution should be as efficient as possible in order for businesses to manage their working capital properly.
Collecting payments efficiently, the business should aim to collect payment as soon as possible, as the longer the payments the longer they would be managing their business, as well as managing their working capital as they would not be able to pay off bills or wages etc.
It can be done by increasing the proportion of cash customers, for example if cash is not possible because of the businesses conditions, the firm should give their customers shorter credit period as early payments should be encouraged by offering The firms can also offer incentives such as discounts for early payments by the customers. Also if the credit is granted, the business can control their debtor which is known as a credit control which involves insuring the debtors are creditworthy before the firm is granting credit and constantly reviewing the credit position of existing customers. In order to manage the business’s working capital, they need to make sure that the business need to minimise spending on fixed assets as it keeps cash in the business make sure that it balances the need for cash and its need for fixed assets.
To also manage the working capital properly, the business needs to control their cost and this can be done by keeping administrative and production cost to a minimum. Saving can be done by upgrading machinery to replace labour which also has an impact on short term capital availability but reduces the working capital requirements over the longer term. Also Stock management can be done as if the business minimises their stock level, their working requirements will become lower and stocks, raw material or even finished goods tie up money together. Some stock management include ensuring an efficient production of products and services and also minimising work progress. Also ensuring goods are delivered correctly to their customers and suppliers and minimising stocks of finished goods.
Furthermore longer term improvement can stem from a move to just in time production, which would reduce stocks of raw materials, and work in progress and finished goods. The firm must balances their cost of stockholding with incentives buy in bulk. By having JIT purchasing which would help minimise stock losses from obsolescence and good warehousing and security reduces other losses on the business.
Causes of Liquidity problems
There are many different liquidity problems which occur in a business as they are not setting aside sufficient money for working capital. This results in a hand-to-mouth existence. If short-term funds are used for purchasing fixed assets this could use working capital problems. There will be constant Pressure to find the money to repay the borrowing. Good management of liquidity and an awareness of external events will be all that is necessary for most businesses to avoid liquidity problems. However, there is always a need to be prudent. Businesses can experience unexpected problems. A firm may feel confident in its liquidity position until a major customer goes into liquidation. Suddenly the debtor’s payment expected next week becomes a bad debt. Often when one firm goes under, others are dragged down with it.
Internal causes of liquidity problems can include things like:
Production problems as Interruptions of production delays the product reaching the market which would prevent the business from making any sales, and problems such as this may occur from strikes as they are a major problem. Marketing problems is also an internal cause of liquidity as if a demand for a product is slow, sales staff may offer longer credit terms to try to shift unsold stocks. Also Management problems as if there is poor stock or production management it would lead to problems with their cost in paying things, which stops them from managing their working capital properly.
External causes of liquidity problems include things like:
Changes to the economic climate which may include inflation, recession or changes to taxation. Also Lower demand which may be caused by recession, changes in fashion or seasonal factors. Unexpected non-payment by customers can be a payment delay and may become a bad debt if the customer goes out of business.
Dealing with Liquidity Problems
Any business may be faced from time to time with a liquidity emergency. In this situation there are several measures that can be taken. The following table shows the measures, the result of them and possible pitfalls.
Control of working Capital
Managing working capital is very important for every business as in many other areas of business it is about - getting the balance right so the business do not go bust. So it is very important that they manage their working capital properly in order for them to keep their business growing and developing, as too much liquidity is wasteful too little can be disastrous. Businesses need to consider working capital requirements right from the outset as it is a very important part in every business there is as it is what the business uses from a day to day basis. Most new businesses underestimate their working capital needs as they do not really know what they need to look out fro or what they need to keep doing in order for the business to function properly without and financial problems. Typically, firms only allow £20 of working capital for every £100 of fixed capital (assets). Accountants usually advise a £50:£50 ratio.
Managing working capital is not just about managing cash flow it is also about the timing and amounts of cash flow there is in the business which is very important. Working capital is mostly about managing the whole business and making sure that the business is running efficiently with its finances, good development and management. Efficient production keeps costs to a minimum and turns raw inputs into finished goods in the shortest possible time. Effective management of stock can have considerable impact on working capital requirements as they are able to save money as well as get a lot of money.
Some ways that business can help control their working capital in the business is in their departments such as for example: Effective marketing as it ensures that the goods are sold and that demand is correctly estimated. This avoids wasted production as if the business had done poor marketing, they would have not sold all their products to their customer meaning production wastage and also loss of money as their product had not been sold. Also efficient distribution gets the goods to the customer quickly were the business can get their money very quickly and manage their working capital better as they would be able to pay off bills, wages equipment of even development of the business. The accounting department can help to control costs the finance of the business to make sure that they do not broke, and Effective credit control improves cash flow. Each of these can reduce the need for cash and/or ensure that sufficient cash is available for the business to meet its objectives.
