3.7 - Cash Flow

Question 1

What is cash

Answer 1

•Its is money that’s gets into the business in the form of: sale of goods, investment by shareholders and funds from financial institutions (i.e. banks).
•Cash is needed to pay day-to-day bills, such as wages, electricity, payment to suppliers, etc.
•Cash is the most liquid asset of the business and it is found in current assets in the Statement of Financial position (Balance Sheet).
•Lack of cash can lead to bankruptcy of the business

Question 2

What is cash flow

Answer 2

•It is the money that flows in and out the business in a particular period of time.
•A positive cashflow will enable the firms to fulfil its day-to-day running costs

Question 3

What are cash inflows and outflows

Answer 3

●Cash Inflows – money received by the business
●Cash Outflows – money paid out by the business in a determined period of time

Question 4

What are 4 reasons profit different from cash flow

Answer 4

•The main difference between profit and cash flow has to do with credit.
•That is, when a firm sales its products (or services) the costumers can pay by cash or credit and that will be positive for the profits but not so much for the cash flows.
•More specifically, if sales increase the total costs there will be a profit. However, if the sales were made by granting credit to the costumers the cash flow will be less than the profit.

Question 5

What is profit

Answer 5

profit is nothing but the positive difference between the total revenue and the costs.

Question 6

When differentiating profits from cash flows, there are two possibilities for the firm, what are they?

Answer 6

A) insolvency
B) have a positive cash flow but be unprofitable

Question 7

What is insolvency and when can it happen

Answer 7

Insolvency – when a business runs out of cash but it is still profitable. This can happen when:
•The firm allowed costumers very long credit periods
•Paying suppliers too early, leaving the firm with little or no cash
•Buying new equipment or new assets in that particular month
•Paying the firms debt with the cash (in that month)
•Buying too much stock with cash that is supposed to cover other costs of the business (also know as overtrading)

Question 8

When can having a positive cash flow but be unprofitable come from

Answer 8

basically the business will have a lot of cash but the sales are not enough to generate profit. This cash can come form different sauces such us:

•Bank Loans
•Sale of some fixed assets for the business (i.e. land, buildings, etc)
•From Shareholders

Question 9

What is a cash flow forecast

Answer 9

•Cash flow forecast is a financial document that shows the expected monthly movements of cash inflows and cash outflows of a business.
•In other words, the movement of cash in and out the business in a given period of time

Question 10

What are the 2 most important terms for a cash flow forecast

Answer 10

A)Opening (Cash) balance - it is the amount of cash the business has at the beginning of every trading period (i.e. Month). It is important to mention that the opening balance is the same value as the previous moths’ closing balance.
b)Total cash inflows – the sum of all the inflows of a particular month (i.e. payments made by debtors, loans from banks, income from renting any property, sales of a fixed asset, etc.)

Question 11

Define total cash outflows

Answer 11

refers to the total cash that leaves the business in a particular month (i.e. rent, bills to be paid, wages, taxes, payment to creditors, etc.)

Question 12

Define net cash flow

Answer 12

its is the difference between cash inflows and cash outflows. This figure should ideally be positive although it is possible that it would be negative if a business is suffering cash flow problems.

Question 13

Define closing balance

Answer 13

Closing (Cash) balance - this is the estimated cash available at the end of every month. Its is calculate by adding the Net cash flow of one month to the opening balance of the same month.

Question 14

What is the order of a cash flow forecast

Answer 14

Opening balance
Cash inflows
Cash sales revenue
Payment from debtors
Rental income
Total cash inflows
Cash outflows
Electricity
Raw materials
Rent
Wages
Telephone
Loan repayments
Total cash outflows
Net Cash Flow
Closing balance

Question 15

What are the advantages of a cash flow forecast

Answer 15

1. It is a very useful document for anyone that wants to “start-up” a business. Providing estimated projections.
2. Allows a business to see when they might need a loan or any other type of finance. If positive, the firm can show its solvency to investors (i.e. Banks)
3. It helps to plan for any unexpected bills/payments they may have in the future. Allowing managers to plan for the future.
4. It helps compare predicted figure with actual figures so the business can assess where the problems lie.

Question 16

What are the disadvantages of a cash flow forecast

Answer 16

1. Only accounts for a small portion of the year
2. Only a rough estimate, not very accurate
3. May not take into account payments that will affect the business in the future

Question 17

What is the difference between a cash flow forecast and statement

Answer 17

There is a difference between cash flow forecasts and cash flow statement.
A cash flow statement is a financial document that shows the details of actual cash inflows and cash outflows of the business, for a period of time.
It can be used TO HELP prepare the cash flow forecasts, which are PREDICTIONS of the cash flows.

Question 18

What are 4 cash flow problems a company might face

Answer 18

•Overtrading – when a business tries to expand to quickly or aggressively without sufficient resources to do it.
•Overborrowing – the more money the firm borrows the more interest they will have to pay (on top of the actual debt)
•Overstocking – when a firm holds to much stock as a result of an ineffective stock control
•Poor credit control – when the firm offers costumers an extended credit period

Question 19

What is investment

Answer 19

•Investment refers to the act of spending money on purchasing an asset with the expectation of future earnings.
•Investment involves wealth creation including the hope that the bought asset value grows overtime.
•Some examples of some financial investments are: buying stocks, bonds or property. All investments are risky specially if there a changes in the market

Question 20

What is the relationship between investment, profit and cash flow in a start up business

Answer 20

• this involves very high investment due to the purchase of initial assets or set up costs
• there is no profit because costs are not yet met
• cash flow is negative - cash outflow is significantly higher than cash inflow

Question 21

What is the relationship between investment, profit and cash flow in a growing business

Answer 21

• investment could still be high because the business is not yet fully established
• there is a small profit as more revenue starts to be generated to cover costs
• cash flow may be positive but low until cash inflow increases especially from sales revenue

Question 22

What is the relationship between investment, profit and cash flow in a established business

Answer 22

• investment may be minimal as the business can plough back profits
• high profit is achieved
• cash flow is positive - cash inflow is higher than cash outflow

Question 23

What are the 3 strategies for feeling with cash flow problems

Answer 23

a)Reducing cash outflows
b)Improving cash inflows
c)Seeking alternative sources of finance

Question 24

How does Negotiate late payment with suppliers and creditors reduce cash outflow

Answer 24

The business will have extra cash for its short-term needs. However, negotiations can be time consuming and relationships with suppliers and creditors might be affected by these.

Question 25

How does the Purchases of fixed assets being delayed reduce cash outflow

Answer 25

The firm can delay the purchase of machinery or equipment (specially the most expensive ones). However, if the machines or equipment are becoming old or obsolete this could affect the efficiency of the business.

Question 26

How does the decrease if some expenses reduce cash outflows

Answer 26

Some specific expenses like Marketing or advertising will not affect the cost of production. However, it could affect the demand for the product

Question 27

How does sourcing from a cheaper supplier reduce cash outflow

Answer 27

This will reduce the cost of raw materials or essential stock but the quality of the product might be compromised and hence affect sales in the future

Question 28

How does leasing rather than buying reduce cash outflow

Answer 28

This will reduce the costs of the firm at least in the short-term. But in the long-term it might be more expensive since the asset won’t belong to the firm.

Question 29

How does using cash payments only Improve cash inflows

Answer 29

This will avoid the problem of delay payments but this might lead the customers to buy from competitors that allow credit

Question 30

How does creating incentives for creditors to pay early improve cash inflows

Answer 30

Offering discounts to pay earlier might help the cash flow. However, this could also create losses for the firm since they will receive less money.

Question 31

How does diversifying the product on offer improve cash inflows

Answer 31

With a better variety of products the business is more likely to generate more revenue through higher sales. But product diversification always comes at a cost.

Question 32

How does changing price policy improve cash inflows

Answer 32

This is a “cut price” (sale) strategy, which only works in the product is at the end of its cycle. Even though this might generate cash, cutting the price on brand new products would definitely create a loss for the firm.

Question 33

How does selling fixed assets improve the relationship between investment, profit and cash flow

Answer 33

This should be focused on obsolete or unused assets. It is not advisable to sell assets that are still needed unless completely unavoidable

Question 34

How does using overdraft improve the relationship between investment, profit and cash flow

Answer 34

Temporarily take more money that exists from the firms’ bank account. However, the interest rate are higher with this resource.

Question 35

How does sales and lease back help improve the relationship between investment, profit and cash flow

Answer 35

Sell assets and the lease back, can generate more cash for the firm. However, this will be more costly for the frim in the long-run since they won’t be able to use the asset as a collateral

Question 36

How does debt factoring help improve the relationship between investment, profit and cash flow

Answer 36

When an external party takes over the ‘debt collection’ for the business paying the debt minus their commission. Even though it is a good way to get cash quickly the firm will not get the full amount of the debt.

Question 37

How does government assistance help improve the relationship between investment, profit and cash flow

Answer 37

Some business qualify for Government grants, subsides or low-interest loans to help increase their cash flows. The negative aspect of this is that Government help comes with specific terms and conditions that the firm will be tied up to.

Question 38

What are the 6 limitation of a cash flow forecast

Answer 38

1) Marketing : Poor market research can lead to incorrect sales forecast. Also, Distasteful or offensive marketing campaigns can affect the sales of the firm.

2) Human Resources : Demotivated employees becomes less productive and can provide poor customer service, less productivity and hence less sales.

3) operations management: Failure or machine breakdown is difficult to predict and will obviously affect production and hence the firms’ cash flow.

4) competitors: It is very difficult to predict competitors behaviour but it is also very linked to the firms cash flow position and success (i.e. Toyota’s aggressive but appealing marketing in the USA directly affected the sales of its competitor General Motors and Ford)

5) change in fashion and taste : A favourable change in demand means that the cash flow will be more positive that originally forecasted. However, the exact opposite might happen.

6) unexpected changes in the economy : Interest rate fluctuations and higher rates of inflation can affect consumer’s behaviour and producer confidence. If changes are positive (i.e. less borrowing interest rate, can lead to more credit access) it will have a positive effect on the firm.