5.27 Cash flows

Question 1

Cash flow

Answer 1

The sum of cash payments to a business (inflows) less the sum of cash payments (outflows)

Question 2

Liquidation

Answer 2

When a firm ceases trading and its assets are sold for cash to pay suppliers and other creditors

Question 3

Insolvent

Answer 3

When a business cannot meet its short-term debts

Question 4

Cash inflows

Answer 4

Payments in cash received by a business, such as those from customers (debtors) or from the bank. e.g: loans

Question 5

Cash outflows

Answer 5

Payments in cash made by a business, such as those to suppliers and workers

Question 6

Debtors

Answer 6

Customers who have bought products on credit and will pay cash at an agreed date in the future
+ Usually big orders

Question 7

Cash-flow forecast

Answer 7

Estimate of a firm’s future cash in and outflows

Question 8

Net monthly cash flow

Answer 8

Estimated difference bw monthly cash in and out flows

Question 9

Opening cash balance

Answer 9

Cash held by the business at the start of the month

Question 10

Closing cash balance

Answer 10

Cash held at the end of the month becomes next month’s opening balance

Question 11

Credit control

Answer 11

Monitoring of debts to ensure that credit periods are not exceeded

Question 12

Bad debt

Answer 12

Unpaid customers’ bills that are now very unlikely to ever be paid

Question 13

Overtrading

Answer 13

Expanding a business rapidly without obtaining all of the necessary finance so that a cash-flow shortage develops

Question 14

Creditors

Answer 14

Suppliers who have agreed to supply products on credit and who have not yet been paid

Question 15

Cash-flow forecasting limitations

Answer 15

+ Mistakes can be made in preparing revenue and costs forecasts
+ Drawn up by inexperienced staff
+ Unexpected cost increases –> inaccurate forecast e.g: Fluctuation in oil prices makes airline companies have misleading forecasts
+ Wrong assumptions being made due to e.g: poor market research

Question 16

Causes of cashflow problems

Answer 16

+ Lack of planning
+ Poor credit control (debtors not being chased up for payment)
+ Allowing customers too long to pay debts
+ Expanding too rapidly (overtrade) –> successful and expanding but not enough cash to pay wages and materials
+ Unexpected events e.g: dip in predicted sales income, breakdown of a machines

Question 17

Ways to improve cash inflows

Answer 17

1. Overdraft: flexible loans
   + Interest rate high
   + Can be withdrawn by the bank –> causes insolvency
2. Short-term loan: Fixed amount borrowed for an agreed length of time
3. Sale of assets: Selling off redundant assets
   + Selling assets quickly –> results in a low price
   + Assets may be necessary for future expansion
   + Could have been used as collateral for future loans
4. Sale and leaseback: Assets can be sold but can be leased back from the new owner
   + Leasing cost add to annual overheads
   + Loss of potential profit if assets rises in price
   + Can be used as collateral
5. Reduce credit terms to customers: Shortening credit terms e.g: 2 months to 1
   + Customers may purchase products from other competitive brands
6. Debt factoring: Buy the customers’ bills from a business and offer immediate cash –> reduces bad debts
   + Only 90-95% of debt value will be paid by debt factoring company
   + May indicating that business is in trouble (lose reputation)

Question 18

Ways to reduce cash outflows

Answer 18

1. Delay payments to suppliers: Cash outflows fall in short term
   + Suppliers reduce discounted offer
   + Suppliers may demand cash on delivery or refuse to supply if they see risk
2. Delay spending on capital equipment
   + Efficiency of business might fall if equipment is outdated
   + Expansion is difficult
3. Use leasing
   + Asset not owned by business–> if machines needed all the time -> costly than buying
   + Add to annual overhead
4. Cut overhead spending that doesn’t affect output directly e.g Promotion costs
   + Future demand may be reduced bc product not advertised effectively

Question 19

Managing debtors

Answer 19

+ Not extending credit to customers. Ev: lose customers potentially (marketing x finance argue)
+ Debt factorings. Ev: cost –> only use to prevent bad debt or emergency
+ Assessing whether new customers are creditworthy - use credit enquiry agency
+ Offer discount to clients who pay promptly Ev: May reduce profit margin of sale

Question 20

Managing credits

Answer 20

+ Increasing the range of goods and services bought on credit Ev: Risky bc unpaid creditor refuse to supply –> cause production hold-ups. Also loses offer by suppliers
+ Extend the period of time taken to pay. Ev: Slow payment by larger businesses is a great burden for small businesses

Question 21

Managing inventory

Answer 21

+ Keeping smaller inventory levels
+ Using computer systems to record sales
+ Efficient inventory control to reduce losses through damage wastage and shrinkage
+ JIT inventory ordering - working capital tied up in inventories will be minimised. More liquid.

Question 22

Managing cash

Answer 22

+ Use of cash-flow forecasts -> arrange overdraft to avoid liquidity crisis
+ Wise investment of excess cash