Cash Flow

Based on Mr. Muenker Slide Presentations

Cash Flow

The movement of an organisation's cash inflows (case received from the sale of goods and services) and cash outflows (used to pay for the costs of running the business). 

Sales Revenue

 The value of goods and/or services sold to customers.

Sales Revenue Formula

*Sales Revenue = Price x Quantity* 

Profit

The value of sales revenue after all costs have been accounted for., This is the money that a business earns. Hence, profit is the positive difference between a firm's sales revenue and its total costs of production. 

Profit Formula

*Profit = Sales Revenue – Total Costs*  

Working Capital

Refers to cash or other liquid assets available to an organisation for its daily operations. Working capital is essential to pay for raw materials, utility bills, and staff wages and salaries. Hence, working capital enables the business to function and trade. 

Working Capital Formula

*Working Capital = current assets – current liabilities* 

Working Capital Cycle

Refers to the duration between the organistation paying for the production costs of a good or service and it receiving the cash from customers purchasing the product. 

Examples of a Slow Working Capital Cycle

Car Companies, Jewellery Stores, and Realtors.  

Examples of a Fast Working Capital Cycle

Hair salons, Convenience Stores, and Taxis,

Positive Working Capital

Generally shows that a business is able to pay off its short-term liabilities very quickly.  

Negative Working Capital

Generally indicated the business is unable to do so. 

Liquidity Positioning

Indicates the extent to which it has sufficient liquidity to continue its business activities. Typically measured through liquid ratio analysis.  

Cash Flow Forecasting

A quantitative technique used by business managers to predict how cash is likely to flow into and out of the organisation for a particular period of time, such as for the next twelve months.  

Cash Inflows

The money going into the business from earning and other sources of finance.

Examples of Cash Inflows

Bank Loans, Bank Overdrafts, Business Angels, Capital injections from the owners of the business, & Cash used by customers to pay for the sale of goods and services 

Cash Outflows

The money going out of a business to pay for its spending. 

Examples of Cash Outflows

Advertising Costs, Cost of Sales, Delivery Charges, Financial Perks, Heating and Lighting Costs, Insurance Premiums, & Packaging Costs 

Net Cash Flow

The numerical difference between an organisation's total cash inflows and its total cash outflows. 

Net Cash Flow Formula

*Net Cash Flows = Cash Inflows – Cash Outflows* 

How does a liquidity problem occur?

When there is a lack of cash in the organisation because its cash inflow is less than its cash flow 

How does a positive net cash flow exist?

If the total cash inflows are greater than the total cash outflows for a given period of time, such as a month or per quarter.

How does a negative net cash flow exist?

If the total outflows exceed the total inflows for a particular time period.  

Opening Balance

Amount of cash at beginning of the period

Closing Balance

Amount of cash at the end of the period

Closing Balance Formula

Opening balance + net cash flow = Closing Balance

Opening Balance Formula

Opening Balance = Closing Balance in Previous Month  

Limitations of Cash Flow Forecasts : Marketing

Poor marketing research can lead to incorrect sales predictions

Limitations of Cash Flow Forecasts : Human Resources

Demoralised workforce can be less productive and deliver poor customer service

Limitations of Cash Flow Forecasts : Operations Management

Machine failure or productive delays

Limitations of Cash Flow Forecasts : Competitors

Behaviour of rivals can affect a firm’s success

Limitations of Cash Flow Forecasts : Changing Fashion and Tastes

Leads to changes in demand

Limitations of Cash Flow Forecasts : Economic Changes

May present opportunities or threats

Limitations of Cash Flow Forecasts : External Shocks

Events such as war, stock market crash, or oil crisis can disrupt normal activity.

Investment

Refers to the purchase of fixed assets (such as equipment and machinery), with the intention of creating a financial return (profit) in the future. 

Cash Flow

The financial return from the trading activities of a business. It is found by subtracting the firm's total costs from its total revenues. 

Profit

The timing of cash flow can impact profitability because these chase flows depends of the product's working capital cycle, so whilst it might be profitable, the fir, can still experience cash flow issues.  

Cash Flow Problems

Arise when an organisation has insufficient funds to run its business, i.e. when net cash flow is negative. Can arise due to internal reasons (such as poor cash flow management) and external factors (such as changes in consumer preferences and tastes).  

Most Common Cash Flow Problems : Overtrading

Expanding too quickly or without sufficient resources

Most Common Cash Flow Problems : Poor Credit Control

Too much credit given to customers who fail to pay

Most Common Cash Flow Problems : Overborrowing

Taking on too much debt

Most Common Cash Flow Problems : Unforeseen Changes

Unexpected or seasonal changes in demand

Most Common Cash Flow Problems : Overstocking

Holding too much inventory

Ways to Reduce Cash Outflow

Negotiate with creditors and supplies to improve trade credit terms. Securing a longer credit period helps to delay cash outflows. 

Pay for purchases of goods and services on trade credit, rather than using cash. 

Opt for leasing capital equipment instead of purchasing such assets. Although this reduces the organisation's net assets on its balance sheet, it can provide much needed liquidity for the firm.  

Reducing stock levels (inventories), as this can reduce cash outflows needed to pay for purchasing stocks. This is particularly important for organisations with a long working capital cycle.  

Ways to Increase Cash Inflows

Raising prices of the products the business sells that have free substitutes or a high degree of brand loyalty. Loyal customers are not overly sensitive to higher prices, so this earns a greater profit margin for the business.  

Reduce prices of the products the business sells that have a high degree of completion.  

Reducing the credit period helps to improve the cash flow cycle, because customers buying on credit pay within a shorter time period. However, some customers may be unhappy about having to pay earlier, so many seek alternative providers that offer better credit terms.  

Encourage debtors to pay their invoices early by offering discounts. This shortens the working capital cycle.  

Ways to Seek Alternative Sources of Finance 

Bank overdrafts or bank loans are common additional sources of finance when faced with a liquidity problem. 

Secure finance from sponsorships, donations or financial gifts. This can help boost cash inflows, thereby improving the cash flow position. However, these sources of finance are not easily accessible to most businesses.  

Selling shares in a limited company in order to raise additional sources of finances. Whilst this could bring in additional cash, it can be an expensive operation, and such options is not available to sole traders and partnerships. 

* In the worse-case scenario, an organisation could sell its fixed assets to raise additional finance.