BST Section 5 Chapter 23 - Cash flow forecasting and working capital

Cash as a liquid asset

Immediately available to spend on goods and services

Cash flow

The cash inflow and outflow of a business over a period of time

Cash inflows

The money recieved by a business over a period of time. ex: Sale of goods,Sale of assets, Payments by debtors, borrowing money, investors.

Cash outflows

The sums of money paid out by a business over a period of time. ex: Purchase of inventory, operating expenses, loan repayments, and capital expenditures.

Cash flow cycle

Shows the stages between paying out cash for labour, materials and so on and recieving cash from the sale of goods.

Stages of cash flow cycle

1. Cash outflow to pay for materials, rent etc.

2. Goods produced (time is needed to produce products)

3. Goods are sold and customers pay for goods with cash. if they purchase on credit, cash is received later.

4. Cash payment recieved for goods sold (cash inflow)

• The longer it takes for cash flow cycle to be completed the greaters will be the firms working capital

• Cash flow is not the same as profit

• Profit is the surplus after total costs have been subtracted from revenue, whereas cash flow is the cash sales of a business in a month

• When profitable businesses run out of cash its known as insolvency

Cash flow forecast

An estimate of a businesses future cash inflow and outflow on a month-by-month basis to show the expected cash balance at the end.

Closing cash balance

The amount of cash a business has at the end of each month

Opening cash balance

The amount of cash a business has at the start of each month

Net cash flow

The difference between the cash inflow and outflow

Inflow - Outflow = Net cash flow

Closing bank balance

Opening bank balance + net cash flow = Closing bank balance

Uses of cash flow forecast

• Starting up a business

• Running an existing business

• Keeping the bank manager informed

• Managing cash flow

Starting up a business

• The first few months when starting a business is crucial and is the time when the most money is needed to spend on land labour and capital, as well as advertising and promotion costs.

• Often new businesses dont understand the importance of cash flow in a business and fail.

• A cash flow forecast would help avoid these problems

Keeping the bank manager informed

• Banks require a firms cash flow forecast to be presented to be able to loan any money needed.

• A cash flow forcast helps a bank manager see how big of a loan or overdraft is required, when it is needed, and how long the finance is needed for and when it will be repaid.

Managing an existing business

• If an existing business runs out of cash and requires a loan or an overdraft.

• Borrowing money nees to be planned in advance to receive low interest rates.

• If loans from the bank arent prepared in advance and are required on very short notice the bank can refuses to loan miney to the business or charge high interest rates.

• If business exceeds overdraft limit from the bank without informing the bank the bank could insist the overdraft be repaid immediately which can lead to the business closing.

Managing cash flow

• Businesses with high bank balances can Use the cash more effectively in other areas such as repaying loans to reduce interest charges and paying creditors quickly to take advantage of possible discounts.

How to overcome short term cash flow problems?

• Increasing bank loans:

  • Bank loans will provide business with more cash

  • Interest must be paid this will reduce profits

  • Loans will have to be repaid eventually which is a cash outflow

• Delaying payments to suppliers will decrease cash outflow for a short time period however suppliers may refuse to supply or offer lower discounts due to late payments

• Askig debtors to pay more quickly so cash inflows increase on the short term however customers may purchase from another business that offers them time to to pay(trade credit)

• Delaying or cancelling purchases of capital equipment so cash outflows for the short term decrease but can affect a business’ efficiency in the long-term without up to date equipment

How to overcome cash flow problems with long term solutions?

• Attracting new investors by selling more company shares but may compromise company ownership

• Cut costs by increasing efficiency using lean production however may not be popular with employees and product quality may decrease

• developing new products to attract customers but could take a long time and requires cash in the short term to pay for development

Working capital

The capital available to a business to pay for day to day expenses

Working capital formula

Working capital = Current assets - Current liabilities

Forms of working capital

• Cash is needed to pay for day to day expenses

• The value of a firms debtors is related to the volume of production and sales.
  To achieve higher sales there may be a need to offer additional credit facilities.

• The value of inventories is also a significant part of working capital since not having enough inventory may cause production to stop. hoever a very high inventory level may result in high opportunity costs.

Why should working capital be handled properly by a business?

It shows investors and banks how efficient a business is and its financial strength.