Cash Flow

  • Cash flow is crucial for businesses; a lack of cash, not profit, can lead to failure.

  • Businesses need enough money to cover expenses like rent and worker salaries to avoid disruptions such as employees leaving.

  • The timing of money coming in and going out is vital, especially for small businesses.

Importance of Cash

  • Cash is needed to pay employees, suppliers, landlords, the government, and interest on loans.

  • Failure to pay employees and suppliers leads to a halt in production.

  • Running out of cash can force a business into liquidation and failure.

  • Cash flow problems are a primary reason for business failure.

Cash Flow Cycle

  1. Cash is needed to pay for materials, wages, rent, etc.

  2. These are used to produce goods.

  3. Goods are then sold.

  4. Cash payment is received for goods sold, restarting the cycle.

  • Some businesses have a fast cash flow cycle, while others are slow, depending on how long it takes to convert resources into cash.

Cash Flow: How It Works

  • Cash flows through a business via revenue and investment, covering costs, wages, taxes, and rent.

Cash Inflows & Cash Outflows

  • Examples:

    • Purchase of a new photocopier for cash → Cash Outflow

    • Wages paid to employees → Cash Outflow

    • Purchase of new premises → Cash Outflow

    • Customers (debtors) pay you → Cash Inflow

    • Interest paid on bank loan → Cash Outflow

    • Business obtains a government grant → Cash Inflow

    • Suppliers (creditors) are paid → Cash Outflow

    • Electricity bills are paid → Cash Outflow

Key Features & Importance of Cash Flow Forecasts

  • Cash flow forecasts show projected cash inflows and outflows.

  • Net cash flow = Total cash inflow - Total cash outflow

  • CF forecasts help businesses identify the timing of cash shortages and surpluses, enabling them to take action like applying for an overdraft or adjusting cash flow timings.

  • CF forecasts assist managers in planning ahead.

  • Starting businesses need cash flow forecasts to apply for finance.

  • Forecasts enable businesses to plan what overdraft they may need.

  • For startups, there are many costs when opening or launching.

Limitations of Cash Flow Forecasts

  • Based on estimated figures, which can be inaccurate.

  • Unexpected events may occur, such as sudden increases in interest rates or new competitors forcing price reductions.

  • Cash flow forecasts focus only on the timing of cash flow and do not explain profits or productivity, which are also important.

Overcoming Short-Term Cash Flow Problems

  • Arrange an overdraft or other forms of finance.

  • Delay payments to suppliers.

  • Ask debtors to pay more quickly.

  • Use cash sales instead of trade credit.

  • Delay or cancel purchases of capital equipment.

  • Rent/lease equipment instead of purchasing.

  • In the long term: cut costs & increase productivity, increase sales by developing new products.

The Difference Between Cash & Profit

  • Example:

    • Goods sold to customers for £120,000 with 40% paid in cash and 60% on one month's trade credit.

    • Cost of goods sold is £80,000, paid by the business in cash.

    • Net Cash Flow = 4800−80000=−320004800 - 80000 = -32000

    • Profit = 120000−80000=40000120000 - 80000 = 40000

Insolvency

  • A very profitable business can still become insolvent by running out of cash due to:

    • Too much trade credit given to customers

    • Expanding too quickly (overtrading) by taking on orders too big or expanding too fast.