Business

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Business Management Studies

• Week 9

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Material this week

• Unit 17 Contribution
• Unit 18 Cash Flow Management
• Unit 19 Control of Working Capital

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Contribution
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Contribution per unit

• If a unit of outputs variable cost is 1.00, but
  it sells for 1.25, then its contribution is 25
  pence.
• However, this is not profit. Profit only occurs
  once the total contribution exceeds overheads.
• Increasing the contribution per unit will
  increase profits. Increasing the price to 1.30
  represents a price increase of just 4 but the
  contribution has risen by 20.
• Contribution is calculated by subtracting total
  variable costs from sales revenue Is useful for
  calculating profits where more than one product
  is produced.

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Example Simpsons Juice
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Introduction of new productsContribution Costing
Fixed costs already covered by other products
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Break Even Contribution Pricing

• The Break-even level of output is between 5,000
  and 10,000 units (8,000 units)
• Break-even fixed costs
  contribution
• Contribution Pricing Ignore the fixed costs. If
  other products are covering fixed costs then any
  new products profit in the short run is its
  contribution to overheads. Providing that is
  positive its price can be set without having to
  make a real profit. This encourages new products
  to be introduced, and gives them time to mature.

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Special Order Decisions-Bulk buying
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Consequences of Poor Cash Flow Management

• Have to delay payment of Bills
• Suppliers may be reluctant to continue supply
• Workers cannot be paid and could stop working
• Creditors could take the company to court
• The company be declared insolvent
• Sole traders could be made bankrupt

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Cash flow management
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• 70 of first year collapses are due to cash flow
  problems
• Cash flow is the flow of money through a company
  and has nothing to do with profits. A Company can
  be cash rich and unprofitable, or cash poor yet
  profitable.Managing Cash Flow
• Forecast future cash flows
• Anticipate periods of cash shortage
• Arrange finance cover (overdraft) monitor debtors
  constantly
• Review times and amounts of receipts and payments
• Constantly compare the actual situation with the
  forecast
• Arrange cover for shortfalls

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Cash flow example(negative figures in bold)
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Banks use cash flow forecasts to ensure the
company

• Has enough cash to survive
• Is able to pay interest on the loan
• Will be able to repay the loan
• Is aware of the need for cash flow management

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Solving Cash Flow Problems 1

• Speeding up cash inflowsNegotiating shorter
  credit for customers average payment is 75
  daysCredit management ensure payments are
  received on timeFactoring the debt factors pay
  you now and collect the debt when its due
• Delaying cash outflowsNegotiating longer credit
  terms from suppliersLeasing rather than buying
  equipmentRenting rather than buying buildings

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Solving Cash Flow Problems 2

• Cutting or delaying expenditureDecrease levels
  of stockCutting costs wages, cheaper inputs,
  energy savings etc.Postponing expenditure new
  company cars for example
• Finding additional funding to cover cash
  shortagesOverdraftShort term loanLong terms
  loanSale and leaseback of assets

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Firm with a 25K Overdraft
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Reliability of Cash Flow Forecasts

• Cash flows forecasts are only as good as the
  estimates they are based on. Using spreadsheets
  to adjust the timings and amounts companies
  should evaluate what would happen under the
  following circumstances
• Sales were lower
• Customers did not pay on time
• Prices of materials went up

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Working Capital

• Capital expenditurefixed assets - machines,
  premises
• Working Capitalwage bills, telephone bills,
  electricity bills

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Liquidity Cycle
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Insufficient working capital

• Firm struggles to pay own bills on time
• Additional interest charges
• Reduces opportunities to bulk buy raw materials
• Money not available for further development
• Ultimately may go out of business

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How much working capital do businesses need?

• The length of the liquidity cycle length of the
  production process the time taken for
  distribution
• The credit given to customers. The credit given
  by suppliers
• Market conditions different markets have
  different credit cultures
• Larger orders can lead to longer credit
  arrangements
• Regular orders regular customers expect
  favourable credit conditions
• Ten percent contingency fund

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Managing working capital effectively

• Obtaining maximum possible credit
• Goods to market as quickly as possible
• Shortest possible credit for customers ( credit
  control)
• Minimising spending on fixed assets
• Control costs
• Minimise stock levels

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Causes of Liquidity Problems

• Large customer goes broke
• Failure to set aside sufficient contingency funds
• Production problems - missing components,
  strikes, etc.
• Marketing problems - sluggish sales can lead to
  longer credit for customers
• Management problems poor management of the
  minimisation of working capital
• Changes to the economic climate inflation,
  taxation, recession
• Lower demand
• Unexpected non-payments customers go broke