Business 3.7

Question 1

Profit vs Cash flow

Answer 1

• The two show different aspects of business
• Better to focus on cash flow than profit in early stages of a business.
• Cash is not always received the moment payment is made but profit is earned the moment sale is made. Thus, it is possible for negative cash flow but earn a profit.

Cash is the most liquid type of asset and a type of current asset. Profit is the positive difference between revenue and costs. If it the difference is negative, it is referred to as a loss. Profit and loss are related to cash flow but they are not the same.

Business may be profitable and yet have negative cash flow (trade credit) because it might have made a sale but, on trade credit, meaning they have to wait for their customer’s repayment. Business have positive cash flow and yet have loss (loans).

Question 2

What is cash inflow

Answer 2

refer to the cash that comes into a business during a given time period, usually from sales revenue when customers pay for the products that they have purchased.

Question 3

What is cash outflow

Answer 3

refer to cash that leaves a business during a given time period, such as when invoices or bills have to be paid.

Question 4

What is working capital

Answer 4

(sometimes referred to as net current assets or circulating capital) refers to cash or other liquid assets available to an organisation for its daily operations.

Question 5

Importance of working capital to businesses:

Answer 5

• Serves as a metric for how efficiently a company is operating and how financially stable it is in the short-term.
• Reflection of various company activities

Question 6

Liquidity vs Cash flow

Answer 6

Liquidity is measured using current ratio and acid test ratio.

Liquidity is an indicator of performance over the past year.

Liquidity ratio is for the past.

Cash flow is not a ratio.

Cash flow shows monthly movement of cash.

Cash flow forecast is for the future.

Cash flow is related to working capital.

Question 7

What is Liquidity position

Answer 7

refers to the extent to which it has sufficient liquidity in order to continue its business operations.

Question 8

What is Liquidity crisis

Answer 8

is a situation that arises when a business is unable to pay its short-term debts. This can eventually lead to bankruptcy.

Question 9

What is Liquidity problem (or cash flow problem)

Answer 9

occurs when there is a lack of cash in the organisation because its cash inflows are less than its cash outflows.

Question 10

How could a business manage its cash flow effectively?

Answer 10

Minimise the number of debtor days and maximise the number of creditor days.

Question 11

What is Cash flow forecasting

Answer 11

is a quantitative technique used by business managers to predict how cash is likely to flow into and out of the organisation for a particular period of time.

Question 12

What is Cash flow forecast

Answer 12

is a document that shows predicted movement of cash in and out of business per time period.

Question 13

What is Opening balance

Answer 13

is the amount of cash the business has in the bank at the beginning of the month.

Question 14

What is Closing balance

Answer 14

is the amount of cash the business has at the end of the month.

Question 15

The importance of a cash flow forecast

Answer 15

1. Help the company plan in advance to prepare for any negative developments over a time period.
   
   • If negative closing balance, then the business may want to take out short-term loan to cover any unexpected expenses.
2. Comparing forecast and actual cash flows to help with budgeting and marketing decisions for the future.
3. Bank and other lenders to assess the business’ financial health.

Question 16

Difference between cash flow forecast and cash flow statement

Answer 16

Remember that a cash flow forecast (CFF) is different from a cash flow statement (CFS).

A CFF is a prediction of the cash flows in and out of a business over the foreseeable future. The CFS shows the actual cash inflows and outflows for a specified time period.

Question 17

Relationship between investment, profit & cash flow

Answer 17

Investment is capital expenditure. → Large initial amount of cash → Negative impact on NCF. However, investment is what supports the business’ profit, thus, it is needed and important.

Question 18

Reasons for poor cash flow

Answer 18

1. Poor stock management: Too much stock at hand and too much cash spent on stocking.
2. Poor pricing strategy or low sales: Lower revenues and inadequate cash inflows.
3. High expenses: Indicates cash outflow is higher than inflow which results in a negative cash flow figure.
4. Seasonal demand: Sales could increase or decrease according to season and could result in low cash inflows.
5. Overtrading: Occurs when a business attempts to expand too quickly without the sufficient resources to do so, usually by accepting too many orders, thus harming its cash flow.

Question 19

What causes cash flow problems?

Answer 19

Inability to increase cash inflows or control cash outflows.

Question 20

What indicates a healthy net cash flow?

Answer 20

Must either increase its cash inflows, reduce its outflows or find additional finance.

Question 21

How to Increase cash inflow

Answer 21

1. Shorten credit period (as creditor):
2. Debt factoring: There are too many debtors (bad debts) and the business is in urgent need of cash. However, not a full payment is received because debt factors needs an amount of fee.
3. Overdraft: Easy to apply, quick cash But, high interest rates.
4. Sale-and-leaseback: Selling non-current assets and leasing them back immediately. In the long-term, ownership of asset is lost and payments have to be made to use it.
5. Effective debt collection: Ensure customers pay on time, perform credit checks on unpunctual customers. However, could discourage customers and lose customers.
6. Cash transactions only: Might lose customers that buy on credit.
7. Increased promotion: Implement new promotion strategies which could increase sales but, could also be costly and increase cash outflows.
8. Expanding product portfolio: Diverse risks and increase cash inflow from a wider range of products, good in the long-run. However, requires cash outflows in the short term.
9. Going public: Effective in raising funds. However, it is a one-time solution and involves additional reporting.
10. Overdrafts: Quickest way to increase inflow. However, overdraft interest rates can be higher than usual rate.
11. Loans: Effective for immediate expenses and are more predictable than short-term loans. Consider restructure short-term loans to long-terms. However, interest payments needed and terms of loan could be altered by bank in the future.
12. Government assistance: Low interest grants and subsidies. Non-profit social enterprises receive preferential tax treatment. Repayment not needed. However, this is all subject to political change and the business cycle.
13. Sales of non-current assets: Do not guarantee stable cash inflow and subject to seasonal fluctuations.

Question 22

How to reduce cash outflow

Answer 22

1. Prolong credit period (as a debtor): Hold onto cash longer. But, risk relationships with suppliers.
2. Switch to cheaper suppliers: Could result in lower quality production which impacts company’s reputation and future sales.
3. Reduce expenses: Could hinder effective operations and leading to lower productivity and sales.
4. Hire purchase: Spread payments across a time period. However, the total cost of the asset might be higher than the original one.
5. Postpone purchase of non-current assets: More extreme version of hire purchase. Not getting any fixed assets a lot but there
6. Better stock management: Ensure that only popular goods are stocked or apply just-in-time stock management but might miss opportunities for profits.