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Evaluate these two options and recommend which one Pura Cosmetics could use to improve the effectiveness of managing its cash flow more effectively - Edexcel - A-Level Business - Question 1 - 2022 - Paper 2
Question 1
Evaluate these two options and recommend which one Pura Cosmetics could use to improve the effectiveness of managing its cash flow more effectively. Extract D Pura... show full transcript
Worked Solution & Example Answer:Evaluate these two options and recommend which one Pura Cosmetics could use to improve the effectiveness of managing its cash flow more effectively - Edexcel - A-Level Business - Question 1 - 2022 - Paper 2
Step 1
Option 1 - overdraft facility
Answer
Pura Cosmetics could consider increasing their overdraft facility to manage cash flow effectively. The company aims to ramp up production to 15,000 units per month. This increase in output would lead to higher cash outflows due to the need for more raw materials and potentially greater operational expenses. An overdraft could provide the necessary funds to continue operations smoothly during this transitional growth period, particularly since December forecasts a negative cash flow of £3,800. With an overdraft facility, Pura Cosmetics can cover immediate cash needs without risking damage to relationships with their retailers.
Step 2
Option 2 - reducing the credit period
Answer
The alternative option is to reduce the credit period given to their retailers. Currently, Pura Cosmetics offers 30 days' credit, which may delay cash inflows. By shortening this period, Pura Cosmetics could improve their cash flow as they would receive payments more promptly, thus enhancing their net cash flow. For example, with the forecasted cash inflow in December of £63,000, earlier cash collection could help avoid negative balances and additional overdraft interest, making the cash management much more efficient.
Step 3
Recommendation
Answer
After evaluating both options, I would recommend that Pura Cosmetics primarily focus on increasing their overdraft facility. This option provides immediate liquidity to support their rapid expansion without disrupting payment terms with retailers. By enabling more flexibility in operations during a crucial growth phase, they can safeguard against potential cash shortfalls while simultaneously considering a gradual reduction of credit periods as their operational stability improves.