13: Using cash flow forecasting

Question 1

Cash flow

Answer 1

The total cash payments (inflows) into a business minus the total cash payments (outflows)

Question 2

Liquidation

Answer 2

This is turning assets into cash and may be insisted on by courts if suppliers have not been paid.

Question 3

Insolvent

Answer 3

When a business cannot meet its short-term debts.

Question 4

Cash inflows

Answer 4

Payments in cash received by a business such as those from customers or from the bank e.g. receiving a loan.

Question 5

Cash outflows

Answer 5

Payments in cash made by a business such as those to suppliers and workers.

Question 6

Importance of cash flow:

Answer 6

• Timings. Cash flow relates to the timing of payments to workers and suppliers and receipts from customers. If a business does not manage the timing of these payments and receipts carefully it may run out of cash even though it is operating profitably.
• Cash flow planning is vital for entrepreneurs as new business startups are offered much less time to pay suppliers than larger fins - shorter credit periods.
• Finance is often very tight at start-up so not planing accurately is of even more significance for new businesses.

Question 7

Examples of cash inflows:

Answer 7

• Owners capital injection
• Bank loans received
• Customers cash purchases
• Debtors payments

Question 8

Debtors

Answer 8

These are customers who have bought products on credit and will pay cash at an agreed date in the future.

Question 9

Credit sales

Answer 9

Value of goods sold to customers who do not pay cash immediately.

Question 10

Examples of cash outflows:

Answer 10

• Lease payment for premises.
• Annual rent payment.
• Electricity, gas, water, telephone bills (variable!)
• Labour cost payments.
• Variable cost payment such as cleaning materials.

Question 11

Cash flow forecast

Answer 11

An estimate of a firm’s future cash inflows and outflows.

Question 12

Net monthly cash flow

Answer 12

The estimated difference between monthly cash inflows and outflows.

Question 13

Opening balance

Answer 13

Cash held by the business at the start of the month.

Question 14

Closing balance

Answer 14

Cash held at the end of the month - becomes next months opening balance.

Question 15

Why businesses forecast cash flows:

Answer 15

• By indicating times of negative cash flow, plans can be put into place to provide additional finance, for example arranging a bank overdraft or preparing to inject more owner’s capital.
• If negative cash flows appear to be too great then plans can be made for reducing these, for example by cutting down on the purchase of materials or machinery or by not making sales on credit, only for cash.
• A new business proposal will never progress beyond the initial planning stage unless investors and bankers have access to a cash flow forecast - and the assumptions that lie behind it.

Question 16

Limitations to cash flow forecasting:

Answer 16

• Mistakes can be made in preparing the revenue and cost forecasts or they can be drawn up by inexperienced staff or entrepreneurs.
• Unexpected cost increases can lead to major inaccuracies in forecasts. Fluctuations in oil prices lead to the cash flow forecasts of even major airlines to be misleading.
• Wrong assumptions can be made in estimating the sales of the business, perhaps based on poor market research, and this will make the cash inflow forecasts inaccurate.