A medium sized components manufacturer
Liquidity is the amount of cash or the assets that can be easily turned to cash. Having insufficient liquidity means the firm could not pay its bills on time. In this case, it may be unable to develop itself, even unable to survive. In this essay, I would like to analyze the possible alternatives open to a medium sized components manufacturer who is facing a liquidity crisis to solve its problem. Firstly, the firm needs to solve the problems inside it, especially in its production. Liquidity problem might be caused by poor management of stock such as ordering too many materials and producing too many products.
So the firm could reduce its production when its stock is still sufficient to sell. Through this way, it can cut the cost of the production. But, the problem is some workers might be fired if reducing the production, and the firm needs to pay them redundancy costs. It would make the situation even worse. Another way to deal with the problem of poor stock control is concerned with marketing. The firm might cut the price of its products in order to sell more. It might not function because it is a components manufacturer; its products are likely to be price inelastic of demand.
That means people may not buy much more even if the prices falls down dramatically. Moreover, if the products are price elastic of demand, cutting the price could help the firm to get money soon by selling more, which is helpful to solve the liquidity problem, but lower price means the more the firm sells, the greater the lost. Thirdly, there are some possible alternatives to the firm in finance. As a public limited company, a possible way for the firm is to raise more share capital. This can function because the firm can raise cash by doing so.
But, it would take a long time to sell the shares and weaken the power of the existing shareholders to control the firm. Moreover, as it is in a liquidity crisis, people may not buy its shares because they cannot feel confident about its future development. One possible alternative that almost all the companies would consider of while facing a liquidity problem is loaning or requesting an overdraft from the bank. This would be quite efficacious because the firm can get a large amount of cash from the bank immediately.
But the risk of its business becomes much higher, and it needs to pay a certain amount of interest to the bank when the loan is due, that would be a great lost. The interest of a short-term loan is much lower than an overdraft, but, in another hand, it is much more difficult to get. These two solutions might not be much useful because they are both short-term, the firm might not solve its problem before they are due. And the long-term loan is better with an even lower interest. Besides, not all the business can loan from the bank.
It is much easier for the public limited company rather than sole trader or partnership. Secondly, the track record of its success is very important because a good record could make the bank confident to lend the firm money. Also, it is very difficult for the firm to borrow money from the bank when the economy is in a recession. To borrow money from the bank, the firm has to make a cash flow forecast which shows its future development and would make the bank confident to lend it money. Then the bank needs to see its gearing.
If its gearing is high, the bank would refuse the requestion of loan because it shows the firm runs higher loan than its equity. To make the gearing lower, the firm could raise more share capital, increase the reserves or repay some loans. Obviously, it is difficult for the firm because it does not have enough money available. In another hand, if the firm fails to loan from the bank, it also could consider of get help from the Department of Trade and Industry (DTI) because DTI can guarantee 70%, even 85% of the loan.
The only requirement is the annual turnover of the manufacture should be below i?? 300,000. The disadvantages are just that the firm has to pay the DTI 1. 5% of the outstanding balance and the loan will be limited between i?? 5,000 and i?? 100,000. Liquidity problem is always caused by late payment of debtors, so the firm needs to get the money owed to them by their customers as soon as possible. It could send a statement to the customers who delay their payments asking them to pay in a short time.
If the customers do not pay the money soon, the firm also can factor their debtors by which they could get the money sooner but would lose a part of the money. In another hand, to gain the money more quickly, the firm could negotiate with their customers to shorten the period during which they pay. Chasing debts and negotiating shorter credits for customers could help the firm get money sooner, but it must be pointed out that it would make the customers uncomfortable most of the time, which would effect its future business.
Liquidity problem is dangerous to the firm because it will force the business to fail if the firm cannot pay the bills on time, so the firm could negotiate with their suppliers about longer credit of its payment. This would work to some extent, but it would be detrimental if its credit reputation becomes low. The suppliers may stop selling it materials, which would make its production suspending. Also, there are some other possible alternatives open to the firm. It could sell some assets to get money and cut its purchases to retain cash.
But these would cut down its productivity and make it unable to develop in a period of time. To conclude briefly, applying for a long-term loan from the bank should be the best possible alternative for the firm to solve the liquidity problem. Managing debts, applying short-term loan and overdraft and negotiating delaying payment are considerable. Such ways as selling assets or reducing purchases are rather detrimental for its further development, but it should know that survival is its basic objective, if it fails in the ideal solutions, it has to do so.
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