3.7 Cash Flow

Question 1

Cash flow

Answer 1

refers to the movement of an organisation’s cash inflow and cash outflows

Question 2

Sales revenue

Answer 2

is the value of goods and/or services sold to customers.

Question 3

Formula of sales revenue

Answer 3

Sales revenue = Price × Quantity

Question 4

Profit

Answer 4

is the value of sales revenue after all costs have been accounted for. This is the money that the business earns.

Hence, profit is the positive difference between a firm’s sales revenue and its total costs of production.

Question 5

Formula of profit

Answer 5

Profit = Sales revenue – Total costs

Question 6

Working capital

Answer 6

refers to cash or other liquid assets available to an organisation for its daily operations.

Question 7

Formula of working capital

Answer 7

Working capital = Current assets – Current liabilities

Question 8

Working capital cycle diagram

Answer 8

Cash in - payments to suppliers/employees - goods produced - goods sold

Question 9

Define the term working capital cycle

Answer 9

refers to the duration between the organization paying for the production costs of a good or service and it receiving the cash from customers purchasing the product.

Question 10

Definition of liquidity position

Answer 10

indicates the extent to which a business has sufficient liquidity to continue its business activities. Being in a good liquidity position means the business can avoid bankruptcy (business closure) as the organization has sufficient liquidity to continue operating

Question 11

Cash flow forecast

Answer 11

financial tool used to show the expected movement of cash into and out of a business, for a given period of time.

Question 12

Cash inflows

Answer 12

the money going into the business from earnings and other sources of finance

Question 13

Cash outlfows

Answer 13

money going out of a business to pay for its spending

Question 14

Net cash flow

Answer 14

is the numerical difference between an organization’s total cash inflows and its total cash outflows, per time period.

Question 15

Net cash flow formula

Answer 15

Net Cash Flow = Cash inflows – Cash outflows

Question 16

What is a liquidity problem

Answer 16

when there is a lack of cash in the organisation because its cash inflow is less than its cash outflow,
i.e., it experiences negative net cash flow.

Question 17

Reasons for cash flow forecast (3)

Answer 17

-banks and other lenders require a cash flow forecast to help them assess the financial health of the business seeking external sources of finance
-Help managers to anticipate and indentify periods of potential liquidity problems
- facilitate business planning

Question 18

Closing balance formula

Answer 18

Closing balance = Opening balance + Net cash flow

Question 19

Opening balance formula

Answer 19

Opening balance = Closing balance in previous month

Question 20

what are cash flow problems

Answer 20

arise when an organization has insufficient funds to run its business, i.e. when net cash flow is negative

Question 21

examples of cash flow problems (7)

Answer 21

-A lack of financial planning resulting in sales revenue being lower than expected

-Poor credit control, which can lead to bad debts (debtors who are unable to pay for their purchases that have been bought on trade credit)

-Poor cost control, resulting in costs of production being higher than budgeted

-Poor inventory control, resulting in overstocking of products (which have cost money to purchase but have yet to be sold to customers)

-Overtrading, i.e. the firm expanding too fast, which increases cash outflows, but not necessarily with the cash inflows

-Seasonal fluctuations in demand for the firm’s goods and/or services

-Unexpected events, such as a crisis or unforeseen costs that arise rapidly.

Question 22

Strategies to reduce cash outflows (4)

Answer 22

-Negotiate with creditors and suppliers to improve trade credit terms. Securing a longer credit period helps to delay cash outflows.

-Pay for purchases of goods and services on trade credit, rather than using cash.

-Opt for leasing capital equipment instead of purchasing such assets. Although this reduces the organization’s net assets on its balance sheet, it can provide much needed liquidity for the firm.

-Reducing stock levels (inventories), as this can reduce cash outflows needed to pay for purchasing stocks. This is particularly important for organizations with a long working capital cycle.

Question 23

Strategies to increase cash inflows (5)

Answer 23

-Raising prices of the products the business sells that have few substitutes or a high degree of brand loyalty.

-Reduce prices of the products the business sells that have a high degree of competition. This can help to attract customers from rival firms.

-Reducing the credit period helps to improve the cash flow cycle, because customers buying on credit pay within a shorten time period.

-Encourage debtors to pay their invoices early by offering discounts. This shortens the working capital cycle.

-improved marketing strategies to attract customers, raise brand awareness, boost sales and develop customer loyalty.

Question 24

Strategies to seek additional sources of finance(4)

Answer 24

-Businesses will often rely on bank overdrafts or bank loans as additional finance when faced with a liquidity problem.

-Secure finance from sponsorships, donations or financial gifts. This can help to boost cash inflows, thereby improving the cash flow position.

-Selling shares in a limited liability company in order to raise additional sources of finance. Whilst this could bring in additional cash, it can be an expensive operation, and such option is not available to sole traders and partnerships.

-In the worst-case scenario, an organization could sell its fixed assets to raise additional finance.