3.7 Cash Flow

cash flow

refers to the transfer or movement of money into and out of an organization.

profit

the difference between revenue generated and total business costs during a specific period of time

cash

is a current asset and represents the actual money a business has. It can exist in the form of cash held in the business or cash held in a bank account.

working capital

the money that a business has available to fund its day to day activities, usually included as net current assets

Working capital = Current assets - Current liabilities

working capital cycle

the time difference between the firm paying cash for its costs of production and receiving cash from sales to customers

cash inflows

money introduced

managing working capital

• debtors and stocks are less liquid, so businesses struggling with working capital will convert these current assets to cash quickly

• requesting an extension of payment terms from suppliers can increase working capital in the short term as cash remains in the business for longer

• making use of short-term borrowing options (overdrafts) can improve a businesses working capital situation

too much working capital

• businesses are likely to be missing out on the benefits of investing it in fixed assets or investments, causing opportunity cost.

• having large amount of stock increases costs due to storage issues

cash flow and profitability

cash flow can be negative while the business is still profitable because of:

• delayed payments

• inventory build up

• high investments

• dept repayments

cash flow forecast

a prediction of the anticipated cash inflows and  cash outflows, typically for a six to twelve month period

cash flow forecasts uses

• Cash flow forecasts support an application for a loan

• Identifies where the business may experience cash shortfalls or cash surpluses so that plans can be made to manage these periods (e.g. arranging an overdraft)

• Cash flow forecasts aid planning and help a business avoid costly mistakes

cash flow forecasts limitations

• Forecasts are usually based on estimates and in reality inflows and outflows may differ significantly

• Cash flow forecasts require appropriate skills, insight, research and time to prepare and update adequately

• External factors that can impact inflows and outflows may not be reflected in the cash flow forecast

strategies for dealing with cash flow problems

• shorten credit period

• debt factoring

• overdraft usage

• sale and leaseback

main causes of cash flow problems

• overtrading (accepts more orders than it can handle, expanding too quickly)

• over borrowing

• over stocking (too much inventory)

• poor credit control (eg: offers customers prolonged credit periods)

• unforeseen changes (unexpected/erratic changes in demand or supply)

strategies to decrease cash outflow

• seek credit terms

• seek alternative, cheaper suppliers

• better stock control (JIT) (reduces inventory costs)

• reduce expenses

• make cash payments only (no credit for customers)

• change pricing policy

• improved product portfolio (to generate more sales revenue)