Sources of Liquidity Problems

There are many factors that lead to liquidity problems.

 

One of the factors, is overtrading, this problem usually occurs in small businesses which try to fund a large volume of production with insufficient working companies. This problem, however, is not only limited to small organizations larger organizations face this problem as well.

 

Another factor is investing too much in fixed assets; funds are usually limited in the early stages of a business and in this stage businesses tend to spend a great deal of money on equipment and other supplies can be detrimental to a businesses resources.

 

Stockpiling is another factor that could cause liquidity problems for a business; many firms buy in bulk to achieve economies of scale, however this is not always achieved and the discounts do not compensate for the extra cost of holding stock. Holding stocks is very expensive.

 

Another factor is allowing too much credit; many firms take advantage of the credit system as they do not have to pay for a particular good or service until a later date and delay payment as much as possible, this can cause problems for the other firm especially if they give the creditors a lot of time to pay them back. The worst case scenario is the firm would have to borrow money during this time because it has insufficient funds at that time.

 

On the other hand, taking too much credit can also cause a liquidity crisis; if the business takes too long to payback the credit that could then damage the firms reputation and effect firms future trades, it could also result in higher interest and lost discounts as the other firm may no longer willing to provide the firm with discounts because the payment has been delayed.

 

Business planning to expand may borrow large amounts in order to finance their expansion. This could result in overborrowing; the danger with overborrowing is that the firm could lose control to the bank or venture capitalist, for example. Successful business expansions are those funded by a balance of borrowed money and capital raised from share issues.

 

Businesses of underestimate inflation when calculating when planning future business decisions and it is also very difficult to predict the rate if inflation accurately as it always increases our expectations. With inflation comes higher interest, which puts pressure on a firm’s liquid resources.

 

Strikes, breakdown of equipment, bad debts and tax demands are all considered unforeseen expenditure which could cause a liquidity crisis. These events are unexpected.

 

Changes in consumer tastes and fashions, changes in demand in general can also cause a liquidity crisis. These changes can lead to an unexpected decrease or increase in demand. Businesses may not be able to compete with the increase in demand if that rises a great deal and they may suffer greatly from a sudden decrease in demand. 

 

Businesses need experienced financial managers to manage the finance of a business, poor financial management and bad decision making can cost the business a great deal.

 

Seasonal factors; some products or services are only popular during a certain time of year businesses with these products or services need to make sure that sale of their products and services can keep them going for another year.

 

How can a firm use credit control to improve their working capital position?

 

Having a tight credit control were the business is firm and strict about receiving the money that they own will help the businesses working capital position as the business will not have to borrow money in situations where they do not receive their money back. The presumed working capital is accurate. A tight and efficient credit control can avoid reduced profitability resulting from bad debts. The business can pay for day to day costs which are presumably small costs without having to reach out to other sources of finance. A tight credit control policy means that the firm will have a strong reputation, and other firms will be forced to pay payments on time. This policy will also help the firms capital in general because the firm will always having strong capital and when it comes to borrowing money as banks and venture capitalists will be more willing to provide them with finance. The firm will not have to delay any production or work , for example, because of insufficient funds in their working capital. A tight and strict credit control company may also provide the company with a competitive edge as other companies in the market might not adopt a tight credit control policy.