1.6.4 Business Survival and cash flow

Question 1

why would a business struggle in the short term even if the long term is profitable

Answer 1

• Many businesses face cash flow problems and need to find some additional finance from time to time → profit is a long term prospect
• When upfront costs of a new business must be paid before sales can take place (outflows are bigger than inflows) , significant working capital will be required → cash can be a short term problem even when long term prospects are good
• If profits do not come in the long run, no sane lender would supply more working capital

Question 1

difference between cash fand profit

Answer 1

Cash is the money available to help the business cover costs. Profit is the difference between sales revenue and total costs .

Question 2

what is a cash flow forecast

why are they used

Answer 2

• Predicts the net cash flow of the business over a future period
• Result is an estimate of the bank balance at the end of each period covered

Businesses use them to
- Identify potential shortfalls in cash balances (if a negative cash balance is predicted then the business needs to ensure it has a sufficient overdraft)
- See whether the trading performance of the business (revenues, costs and profits) turn into cash
- Analyse whether the business is achieving the financial objectives set out in the business plan (will almost certainly include some cash flow budget)

Question 3

why are cash flow F needed

Answer 3

Cash flows are needed when:
- to predict the timing and significance of any potential shortfalls
- To identify possible corrective action
- To help secure finance from potential investors or the bank
- To give confidence about short term survival
- To provide a guide against which to measure actual cash flow

Question 4

importance of cash flow forecasts

Answer 4

• Cash flow is the lifeblood of a business - particularly startups and small enterprises
• When inflow lags behind outflow, cash dries up and investors demand payment and bills need to be paid → cash flow is crucial for staying in business
• Identifies potential shortfalls in cash balances in advance → early warning system
• Makes sure the business can afford to pay suppliers and employees (strikes, loss of business etc) by seeing if the CF will be positive or negative
• Spot problems with customer payments → which customers pay their debts on time
• As an important discipline of financial planning → important in the management process (business budgets)
• External stakeholders such as banks may require a regular focast like a cash FF → if the business has a bank loan they will want to look at CFF at reg intervals

Question 5

factors affecting cash flow

Answer 5

• Transaction types → sales, purchases, payment terms
• Timings of cash flows → seasonal sales, timing of payments
• Nature of business → start up and capital costs, time taken from input to output, stock holdings

Question 6

cash flow problems

Answer 6

• Businesses need to have sufficient cash to meet day to day finances (buying stock, paying wages, utility bills)
• Insufficient liquid cash funds may mean an inability to meet short term debts (bank overdrafts, payables)
• Limited cash may lead to missed opportunities
• Is the cash flow problem short or long term

Question 7

how to improve CFF

Answer 7

• Increasing the volume of the inflow of cash
• Reducing the volume of the outflow of cash
• Slowing down the timing of the outflow of cash
• Speeding up the timing of the inflow of cash

Question 8

Use of a cash-flow forecast to identify credit requirements and minimise risk

Answer 8

• By monitoring the closing balance, the business can see how much cash they have at the bank on a monthly basis
• If the closing balance is negative, it is prompt to seek extra finance (overdraft or loan)
• An overdraft allows a business to spend more thna it has in its account up to an agreed limit (flexible, suited to CF problems)
• Loans have a lower interest rate and a fixed amount → for when the business has insufficient working capital
• If cash flow problems can be foreseen it may be possible to plan ahead and reduce the payments going out, or delaying payments
• Items such as advertising can be postponed
• May be possible to persuade debtors to pay up early to increase cash coming in