27. Forecasting cash flows Flashcards
Define cashflow
The sum of cash payments to a business (inflows) minus the sum of cash payments (outflows)
Define cash inflow
Payments in cash received by a business such as those from debtors
Define cash outflow
Payments in cash made by a business such as those to suppliers and workers
Define liquidation
When a firm ceases trading and its assets are sold for cash to pay suppliers and other creditors
Define insolvent
When a business cannot meet its short term debts
Difference between cash and profit
Cash is the money that the business has to pay its bills, or the bank when they demand payment. Cash is the money available for use at a certain moment in time. Cash can come from profit.
Profit is earned from running the business well. Profit is earned over a period of time
The need to hold a suitable level of cash within a business, and the consequences of not doing so
If a business runs out of cash and cannot pay its suppliers or workers it is insolvent. The owners must raise extra finance or cease trading
Define cash-flow forecast
Estimate of a firm’s future cash inflows and outflows
Define net monthly cash flow
Estimated difference between monthly cash inflows and outflows
Define opening cash balance
Cash held by the business at the start of the month
Define closing cash balance
Cash held at the end of the month and becomes next month’s opening balance
Uses of cash flow forecast
- Identify potential shortfalls in cash balances in advance
- Make sure that the business can afford to pay suppliers and employees.
- Spot problems with customer payments – preparing the forecast encourages the business to look at how quickly customers are paying their debts.
- As an important discipline of financial planning – the cash flow forecast is an important management process, similar to preparing business budgets.
- External stakeholders such as banks may require a regular forecast.
Limitations of cash flow forecast
- Mistakes can be made in preparing the revenue and cost forecasts or they may be drawn up by inexperienced entrepreneurs or staff
- Unexpected cost increases can lead to major inaccuracy. Fluctuation in prices
- Wrong assumptions can be made in estimating the sales of the business, maybe because of poor market research
Define credit control
Monitoring of debts to ensure that credit periods are not exceeded
Define bad debt
Unpaid customers’ bills that are now very unlikely to ever be paid
Define overtrading
Expanding, a business rapidly without obtaining all of the necessary finance so that a cash flow shortage develops
Causes of cash flow problems
- Poor credit control: debtors will not be chased up for payment and potential debts will not be identified
- Allowing customers too long to pay debts: reducing short term cash inflows => cash flow problems
- Expanding too rapidly: has to pay for expansion before it receives cash from additional sales
- Unexpected events
2 ways to improve cash flow
- Increase cash flows
- Reduce cash outflows
How to reduce cash outflows?
- Delay payments to suppliers
- Delay spending on capital equipment
- Use leasing, not outright purchase, of capital equipment
- Cut overhead spending that does not directly affect output e.g. promotion costs
Delay payments to suppliers
- Cash outflows will fall in the short term if bills are paid after
- Suppliers may reduce any discount offered with the purchase
- Suppliers can either demand cash on delivery or refuse to supply at all if they believe the risk of not being paid
Delay spending on capital equipment
- The efficiency of the business may fall if outdated and inefficient equipment is not replaced
- Expansion becomes difficult
Use leasing
- The asset is not owned by the business
- Leasing charges include an interest include an interest cost and add to annual overheads costs
Cut overheads spending that does not directly affect output
- These costs will reduce production capacity and cash payments will be reduced
- Future demand may be reduced by failing to promote the product effectively
How to increase cash inflows?
- Overdraft
- Short-term loan
- Sale of assets
- Sale and leaseback
- Reduce credit terms to customers
- Debt factoring
Sale of assets
- Selling assets can quickly can result in a low price
- The assets might be needed later for expansion or as a collateral for future loans
Sale and leaseback
- Assets can be sold, but the asset can be leased back from the new owner
- The leasing costs add to annual overheads
- There could be loss of potential profit if assets rise in price
- Could’ve been used as a collateral for future loans
Debt factoring
- Only about 90-95% of the debt will now be paid by the debt factoring company - this reduces profit
- The customer has the debt collected by the finance company - this could suggest that the business is in trouble
