Cash Flow Problems Are One of the Most Common Reasons for Business Failure - Coursework Example

Cash Flow Problems Are One of the Most Common Reasons for Business Failure Cash Flow Problems Are One of the Most CommonReasons for Business Failure For any business to survive successfully in the current competitive business environment there must be a substantial movement of money into and out of the business, a situation refereed to as cash flow. Every business or project has a specified period during which it measures its cash flow to enable it to determine its value. Cash flow measurements enable a business to realize if, in any case, there is a problem with its ability to fulfil its short-term commitments. According to1, any business may be profitable but still fail when it runs out of cash as shortage of cash leads to failure in paying debts as they become due. Cash flow problems arise whenever cash flow is consistently negative in the business and it uses up its cash balances making it to be unable to pay its debt in time2. Cash flow problems lead to a fatal failure in the operations of the business and may gradually bring the whole business to a halt. It is the purpose of this paper to discuss the reasons as to why cash flow problems lead to a business failure. Additionally, the paper discusses other causes of business failure and the measures in avoiding business failure. Cash flow problems arise due to poor cash flow managements and this leads to vast negative effects on the business, such as business failure. Uneven cash flow renders a business insolvent after a very short period and this have adverse effects on the profits margins of the business3. Some of the major reasons why cash flow problems lead to business failure are: 1. Uneven cash flow leads to the inability to meet the monthly expenditure in the business. This puts the business in a situation of having to borrow cash from other businesses or having to cut down on the monthly expenditure. As a result, the profit made from the business reduces and the business may not be able to fulfill its debts. The continuation of this trend gradually lead to the failure in the business as the business runs out of cash that is necessary for covering its expenses. It is thus, necessary for the business to make the necessary commitments to have a constant flow of cash into the business in order to meet the necessary expenditure. 2. Inefficient cash flow management leads to late settlement of customer payments/invoices. The success of any business relies on the good relationship between the business and the customers4. The involvement of the customers with the business generally leads to a constant cash flow in the business. The business need to ensure that it spreads out its expenditure as much as possible and make sure that it strictly follows the customer payment terms. The choice of the customer payment method, however, depends on the nature of the business as well as the customer’s demand. The failure to follow these payment terms leads to mistrust between the business and its customers, an automatic recipe for business failure. 3. Cash flow problems results from an imbalance between cash inflow and cash outflow. Cash outflow occur in business during operations such as the payment of large amounts of money for raw materials, the purchase of new apparatus and equipments, as well as in situations whereby there is a drop in the demand of the company products and services5. The continuation of circumstances leads to a sharp decline in the cash flow and if the cash inflow is persistently low, the business ends up to be making more losses than profit that leads to its closure. Evidence/Examples of factors leading to cash flow problems Several factors lead to cash flow problems in any business and this section discusses a few of them such as: 1. Making low profits and/or losses – whenever a business continually makes losses in its operations, it is pure evidence that it is experiencing cash flow problems. Businesses that run for a certain period with consistent occurrences of low cash inflow eventually close down due to low cash for settling expenses. 2. Over –investment in facilities – this occurs in case a business plans to improve its production capacity and end up spending a large amount of money in the purchase of facilities and equipment. Certain equipments purchased may be used for only a short period and finally they use is halted. The purchase of these equipments then become a waste of money as they are, then, not able to generate any substantial revenue. This reduces the cash inflow to the business affects its growth6. 3. Keeping too much stock – whenever a business holds too much stock, the cash used in purchasing these products are tied up thus generates no income. Keeping too much stock also comes with the challenge that the kept material may expire or become obsolete thus making its sale impossible7.This reduces the expected cash inflow from the sale of these products and with time, the effects of cash flow problems arises in the business that may lead to its closure. 4. Over-trusting customers with financial transactions-, certain businesses extremely trust their customers to the extent that they end up allowing them too much credit during purchase of goods and services. Offering customers credit is a useful method of retaining customers as well as building revenue8. However, it may not approve to be appropriate if the customers pay their credits late as this puts a strain in the cash flow. When a large number of customers owe the business much payment and end up paying the amount slowly, the business may not be able to meet its financial obligations at the end of a specified financial period. This creates imbalance in the cash flow of the business and its continuation may lead to a closure of the business. 5. Overambitious moves in the business such as quick business expansion- a business may have ambitions of expanding into other potential areas to increase its revenue income. However, if the move is too quickly, the business ends up putting a lot of pressure on its short-term finance. If a number of branches start even before the business start making profits in the previous ones, there will be a negative effect on both the cash inflow and cash outflow in the business, as low profits come from huge capital investments. This cash flow problem may lead to slow business growth, or worse, closure of the business due to inadequate capital to maintain its daily operations. Ways of avoiding business failure Some of the ways that are useful in avoiding business failure are; 1. The management team or the business owner should lead in defining all operations and procedures. The management of the business should be able to analysis all the operations of the business. It should set up procedures in handling cash flow problems in the business. The personnel who assist in running the business should also receive reasonable compensations9. This makes it possible to avert any situation that would lead to loss of money in the business, as well as identifying the personal who are capable of handling a specific operation in the business. 2. Follow up and protection of the business assets. The business management should be able to identify all the areas where they have put their investment and asses the profitability of these investments. Knowledge of how each component of a business operates and progresses is a key to evaluating a business’ value and viability. The business should aim at analyzing all its assets, protecting them and ensuring that the profits they generate are maximized10. Failure to analyses the progress of each asset in the business strains the income of the business and may lead to the business failure. 3. Planning a future for the business-, the purpose of any business is to boom financially in its market and expand operations if possible. This is worth realizing by planning the expected way of running the business in the near future. Planning future for the business ensures that the business makes informed information and financial projections on how it will handle its operations when that time arrives. This eliminates uncertainty and financial blackouts in the business, in the face of stiff completion in the market. 4. Marketing of the business – the business only thrives if it has a stable supply of customers. Marketing of the business exposes the products and services of the business to a large number of markets, both locally and globally (Broussard 35). This is a sure way of connecting the business to the consumers and leads to the expansion of the business. However, marketing may lead to a large amount of financial spending, depending on the applied medium of marketing. 5. Facing market competition with effective strategies-, the market of any business is flooded with a stiff competition from other players in the field who, as well, are seeking market dominance. Completion may lead to a total business failure if given an ineffective approach relative to other competitors. It is necessary for a business to analyze the current market trends, what consumers expect to find in the market, and the most effective technology that increases productivity11. The forces of market demand and prices are an essential measure of determining which criteria to use in achieving market dominance. Certain business owners even go to the extent of employing their competitors’ production methods, besides theirs, to achieve relative advantage in the market. In any way, every business should strive to be relevant to the market demand to avoid stiff competition that may lead to its failure. Reasons for business failure 1. Lack of experience – for a business to thrive successfully, the management as well as the support team in the business, should have at least gathered some experience in the field of their business before its start. This makes it easy to make important but crucial decisions that affect the business operations. A business that is started and run by inexperienced entrepreneurs has a risk of failure if, especially if its management does not sort for expertise advice in facing the ever stiff completion in the market12. Experience is also a recipe necessary in producing goods and services that are of high quality to the customers. 2. Insufficient capital – capital is a huge component of daily operations in any business. If a business, faces financial problems every now and then, its ability to meet the production capacity expected in the market is hindered13. Low capital also means the application of simple production techniques, as well as low production capacity. This has the effect of reduced demand for the goods and services of the business in the market, besides stiff competition. Low cash flow then, leads to the closure of the business when it is unable to meet its financial obligations. 3. Poor location – the location of a business has a direct influence in its growth, both finally and in terms of volume of products produced14. Areas that have high demand for the goods and services of the business and low competition, lead to a steady growth of the business. However, areas of low demand for goods coupled with stiff competition lead to the termination of any business following from the continuous scarce cash inflow. 4. Personal use of business funds- if the management team use the funds from the business in their personal problems, the business losses a lot of substantial income that are crucial for expanding its operations. Continuous use of funds for these personal ventures, finally lead to bankruptcy in the business, where operations halt and the business id brought to a halt. Besides these reasons, there are numerous reasons that lead to business failure including poor inventory management, over-investment in fixed assets, poor credit arrangement management, low sales, and the cash flow problems discussed above. Thus, the reasons put above demonstrate that cash flow problems constitute one of the reasons for business failure. The reasons for business failure discussed above all rely on the presumption that there is already a steady cash flow into the business. Any business cannot survive if there is a consistent cash flow problem in its operations. All businesses aim at realizing maximum profits in every operations and assets that they run. If the business produces a constant cash outflow problems, such as huge capital investments in machines, purchase of excess raw materials, and quick expansion strategies; it become imminent that the business may be headed for a fail. If the cash outflow flux outweighs the cash inflow flux, then the business has to strain on the available capital that if not sufficed by a constant income, may finally run dry and lead to business failure. Bibliography Adalikwu, Chris. "Customer relationship management and customer satisfaction." African Journal of Business Management 6.22 (2012): p. 233-256. Broussard, John Paul Buchenroth. "CEO Incentives, Cash Flow, and Investment." Financial Management 22 June 2004: p. 34-37. Cloud, Barbara Lee. The business of newspapers on the Western frontier. Reno: University of Nevada Press, 1992. Hays, Richard D.. 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