3.5.4 - Improving cash flow and profitability

Improving cash flow

Cash flow improves when receipts arrive sooner or increase, payments occur later or decrease, or appropriate finance bridges a timing gap.

A business with late-paying customers can improve collection by invoicing promptly, checking creditworthiness and following up overdue balances. An early-payment discount may accelerate receipts but reduces the amount collected.

Cost of an early-payment discount

A wholesaler offers 2% off a £10,000 invoice for payment this month.

1. Calculate the discount:

1. Calculate the earlier receipt:

1. Compare the £200 cost with the benefit of having £9,800 earlier and whether the customer would have paid promptly anyway.

Timing and the remaining cash shortfall

A caterer has £5,400 available but must pay £14,000 this week. A £9,600 client invoice is not due for another month. The client offers to pay now for a 5% discount.

1. Calculate the accelerated receipt:

1. Combine it with the available balance:

1. The receipt covers this week's bill, leaving £520. The £480 discount sacrifices income but resolves the stated timing gap; other future commitments still need checking.

Reducing excessive inventory can release funds tied up in stock and lower storage or wastage payments. It does not mean that all inventory should be removed: stockouts can interrupt production or lose sales. Better forecasts and reliable suppliers make a lower inventory level more feasible.

Negotiating longer supplier credit can delay payments. It may bridge the customer's payment period, but a supplier might raise its price, remove a discount or refuse future orders. Agreeing terms is different from simply paying late. Small suppliers may be especially vulnerable, creating an ethical and operational issue for the buyer.

Selling an unused asset can raise cash, although it is normally a one-off receipt and may reduce future flexibility. Factoring, an agreed overdraft or other suitable finance can cover a temporary gap. Borrowing improves the immediate cash position but introduces future repayments and costs. It is not additional sales revenue or proof of profitability.

The best action depends on the cause and timing of the shortage. Faster invoicing helps a receivables problem; it does little for a business with almost no sales. Deferring a necessary machine purchase protects cash now but can restrict capacity later. An updated forecast should show both the immediate improvement and the later payment obligations.

On 13 March 2020, Morrisons announced immediate payments for qualifying small suppliers and temporarily extended eligibility to businesses supplying up to £1 million annually, rather than £100,000. Paying earlier supported suppliers' cash during the pandemic. This real response shows why preserving a buyer's cash by extending supplier terms can conflict with supplier resilience and continuity. Morrisons' supplier-payment announcement.

Improving profit and profitability

Profit improves when revenue rises more than costs, or when costs fall more than any associated revenue loss.

Revenue can rise through a higher selling price, greater sales volume or a different product mix. Each route has conditions. A price increase can raise contribution per unit but reduce demand. Selling more can require extra promotion, workers or capacity. Directing customers towards higher-margin products works only if customers want them and the business can supply them.

A price rise with a modest volume loss

A café sells 1,000 meals at £12, with £8 variable cost per meal and £2,000 fixed costs. After raising price to £13, it forecasts 900 sales.