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Understanding Cash Flow in Working Capital Management

Cash flow is the lifeblood of any business, cycling into, around, and out of operations. Effective cash flow management ensures that a profitable business generates surplus cash which can be reinvested or used to pay off creditors. However, businesses may face cash shortages due to overtrading, where the timing of cash receipts lags behind payments. To improve cash flow, companies should aim to speed up collections from debtors and reduce working capital investments in inventory. This strategic approach enables businesses to lessen borrowing needs, lower interest costs, and explore new investment opportunities.

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Understanding Cash Flow in Working Capital Management

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  1. How does Cash flow through Working Capital? • Cash flows in a cycle into, around and out of a business. • It is the business's life blood and every manager's task is to keep it flowing and use it to generate profits. • If a business is operating profitably then it shouldgenerate surplus cash. • If there are cash shortages while growing and showing a profit the business is probably “overtrading” –cash problems are due to timing differences when cash receipts from debtors lag payments due to creditors. See next slide. • The more the growth the bigger the problem • The more debtors / stock a business has on hand, the bigger the investment in working capital

  2. So - Why Reduce Working Capital ? • If a business can get money to move faster around the cycle (e.g. collect money due from debtors more quickly) or reduce the amount of money tied up (reduce inventory levels relative to sales) .. • ..the business will generate more cash to pay off creditors, so it will need to borrow less money to fund working capital .. • .. and reduce the cost of bank interest • .. and may have other investment options - the next investment in stock, other projects • If improved terms can be negotiated with suppliers, ie get longer credit, finance needed for working capital from other sources is reduced

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