Cash Flow Forecasting and Working Capital

Cash Flow and Working Capital

Importance of Cash

Cash is a liquid asset, meaning it's readily available for spending. Cash flow, defined as cash inflows and outflows over a period, differs from profit, which is revenue minus total costs. Insufficient cash can lead to:

• Inability to pay workers, suppliers, landlords, and taxes.
• Cessation of production due to unpaid workers.
• Liquidation, forcing the sale of assets to cover debts.

Cash Flow Components

Cash Inflow

Cash inflow refers to the money a business receives. Examples include:

• Sales of products for cash.
• Payments from debtors.
• Borrowing money (which must be repaid).
• Sale of business assets.
• Investments from shareholders.

Cash Outflow

Cash outflow refers to the money a business pays out. Examples include:

• Purchasing goods or materials for cash.
• Paying wages, salaries, and other expenses.
• Purchasing non-current assets.
• Repaying loans.
• Paying creditors.

Cash Flow Cycle

The cash flow cycle illustrates the progression from cash disbursement for labor and materials to cash receipt from sales:

1. Cash is used to pay for materials, wages, rent, etc.
2. Goods are produced.
3. Goods are sold.
4. Cash payment is received from goods sold.

Cash Flow Forecasts

A cash flow forecast estimates future cash inflows and outflows, typically on a monthly basis. This forecast helps managers determine:

• Available cash for paying bills, repaying loans, and buying fixed assets.
• Potential need for bank loans to avoid insolvency.
• Whether excess cash could be used more profitably.

Managers use cash flow forecasts to ascertain the future cash position of their business.

Key Definitions

• Net Cash Flow: The difference between cash inflow and cash outflow. Expressed as: Net Cash Flow = Cash Inflow - Cash Outflow
• Closing Cash Balance: The amount of cash a business holds at the end of the month. It's calculated as: Closing Cash Balance = Net Cash Flow + Opening Balance The closing balance becomes the next month's opening balance.
• Opening Cash Balance: The amount of cash a business holds at the beginning of the month.

Cash Flow Problems

Cash flow problems arise when a business lacks sufficient funds, resulting in negative net cash flow. These issues can stem from internal factors (e.g., poor cash flow management) or external factors (e.g., changing consumer preferences).

Causes of Cash Flow Problems

• Lack of financial planning, leading to lower-than-expected sales revenue.
• Poor credit control, resulting in bad debts.
• Poor inventory control, leading to overstocking.
• Overtrading (expanding too rapidly).
• Seasonal fluctuations in demand.
• Unexpected events or crises.

Strategies for Improving Cash Flow

Reducing Cash Outflows

• Negotiate better trade credit terms with creditors and suppliers.
• Pay for purchases on trade credit instead of cash.
• Lease capital equipment rather than purchasing.
• Reduce stock levels.

Increasing Cash Inflows

• Raise prices for products with few substitutes or high brand loyalty.
• Reduce prices for products in highly competitive markets.
• Offer discounts for early invoice payments.
• Improve marketing strategies.
• Use a debt factoring service.

Seeking Additional Finance

• Use bank overdrafts or loans.
• Secure sponsorships, donations, or financial gifts.
• Issue shares in a limited liability company.
• Sell fixed assets.