3.7 Flashcards
Cash flow
Money that flows in and out of a business over a given period of time
Profit
The positive difference between sales revenue and total costs
Profit formula
Profit = sales revenue - total costs
Net cash flow formula
net cash flow = cash inflow - cash outflow
Working capital
Current assets - current liabilities
Working capital definition
The money needed to pay for day-to-day running cost of a business which includes wages, purchasing raw materials, paying for electricity and gas. To ensure there is sufficient working capital, current assets must be larger than current liabilities
Liquidity position
The ability of a business to raise cash as needed when a business is able to convert assets to cash to pay off their obligations. It’s in a good position.if it’s the opposite then the business could run into working capital problems and face the liquidity crisis including insolvency.
Cash flow forecast
The future prediction of a firm’s cash inflows and cash outflows over a certain period of time
Cash flow forecast title
Cash flow forecast for XYZ Ltd for the first x months of trading
Benefits of cash flow forecasts
- Useful planning document to start a business, a clarifies the purpose of the business and provide provides projections for future performance
- Provide a good support base for businesses intending to apply for funding from financial institutions which enables the banks to check on the business’ solvency and creditworthiness
- Helps managers identify periods where the business may need cash and plan accordingly to source it
- Helps monitor and manage cash flow by making comparisons between the estimated figures and the actual figures
Investment
The act of spending money on purchasing an asset with the expectation of future earnings
Strategies for reducing cash outflows
- Negotiate with suppliers or creditors to delay payment which helps it have working capital for short term needs.drawbacks are time-consuming and an effect on the relationship with suppliers
- Delay purchases are fixed assets.drawback is that the current machine may become obsolete or outdated leading to less efficiency and higher costs
- decrease specific expenses that don’t affect production capacity such as advertising costs.this may reduce future demand for business’ products
- Look into sourcing cheaper suppliers which will reduce costs for materials or essential stock decreasing outflow.the quality of the product may be compromised
Strategies for improving cash inflows
- insist customers pay with cash only when buying goods. This avoids delayed payments from debtors. Business may lose customers who prefer to buy with credit.
- Offer discounts or incentives to encourage debtors to pay early which reduces the debt burden. businesses will receive less cash than previously expected
- diversify the product offering which will help increase variety of goods to customers which can potentially increase sales. Note that diversification involves higher costs and no guarantee of sales.
Additional finance source
- Sale of assets: sell obsolete, fixed assets to generate cash
- Arranging bank overdraft: this helps during times of immediate cash setbacks however there is a high interest payment
- Sale and leaseback: acids can be sold to generate cash and then these can be leased by the business for production.leasing can prove costly in the long run and is not a source of collateral.
Limitations of cash flow forecasting
- unexpected changes in the economy such as fluctuating interest rates could affect firms borrowings
- Poor market research which would lead to improperly done sales forecasts
- Difficulty in predicting competitors behaviour where they may change their strategies and make it harder to predict their actions and compete with them
- Unforeseen machine or equipment failure which is difficult to predict and can affect cash position
- Demotivated employees which will negatively affect the productivity of workers reducing output or sales and leading to lower cash inflow
