Hal is encountering a situation where it cannot meet its short-term liquidity requirements. As such, most of its cheques issued to its supplies are bouncing owing to the insufficient amounts in the bank. Cash flow is a key indicator of the financial situation of an entity as opposed to revenues statements that may contain non-cash revenues, which give a deceptive picture. In Hal’s case, there are a variety of reasons that are triggering the liquidity problems.
First, most of its sales are made on credit. Only 10 percent of its turnover are on cash basis. This limits the amounts of liquid funds in the entity. Furthermore, the rate at which the amounts are paid is low. This further compounds the problem that Hal is facing. Once credits sale are made, the debtor should pay up within three months. However, Hal only considers any payment of debtors as late once it exceeds ten months from the due date.
This is a lengthy period that Hal has provided. Subsequently, the debtors can delay payments for a long period without any consequences. This situation has contributed significantly to the liquidity problems in the entity since most of its funds may be held up as debtors (Coyle, 2000).
The entity also has many cash commitments. These commitments include the cash payments of the material delivered by suppliers. Additionally, it pays its employees promptly. The cash requirements in this entity are massive after its suppliers denied them credit facilities.
Subsequently, the cash requirements in the entity will outstrip Hal’s cash inflows. The entity also incurs a certain cost when collecting funds form cash sales. The above problems have resulted in the current liquidity problems that Hal is encountering (Nesvetailova, 2010).
Solutions
The only way to solve the above liquidity situation is by boosting Hal’s cash inflows. First, the entity should attempt to increase its cash remittances by encouraging cash payments. Hal can accomplish this by proposing discounts to clientele ready to transact on cash basis. By adopting such measures its can increase the proportion of its cash sales to about 15-20%.
The second measure the entity should undertake is to change the manner in which its debtors pay their debts. The entity should demand that debtors pay on a 50-30-20 basis. This will ensure that the entity has adequate funds. The remittances by the debtors have been a key cause of financial woes at Hal.
The entity should also reduce the period beyond which remittances are considered late. Currently, Hal allows ten months. Hal should reduce the period to six months. This would boost the rate of payment of its debts. Additionally, the entity should enact penalties for late payments. Instituting such policies would increase discipline in the remittance of the debts. Hal should also seek an institution that will charge lower that 2.5% for deposits made.
This is a significant margin which has reduced this entity’s funds levels. Finally, the entity should negotiate better terms with the various parties it pays. Suppliers have denied them credit facilities. If Hal can negotiate fresh terms with its suppliers, then it will incur reduced cash outflows.
Hal should also review its employment policy. It should encourage permanent employees who may reduce its salaries overheads (Neely, 2002). The above details elaborate how the above entity can address the current liquidity problems that it is encountering.
References
Neely, A. (2002). Business performance measurement: Theory and practice. Cambridge: Cambridge University Press.
Nesvetailova, A. (2010). Financial alchemy in crisis: The great liquidity illusion. London: Pluto Press.
Coyle, B. (2000). Cash flow forecasting and liquidity. Chicago: Glenlake Pub. Co.