Chapter 23: Cashflow forecasting and working capital Flashcards
What is cash flows
The business’s cash inflows and outflows over a period of time
Problems because of a lack of cash flow
» being unable to pay workers, suppliers, landlord, government
» production of goods and services will stop – workers will not work for no pay and suppliers will not supply goods if they are not paid
» May be forced into ‘liquidation’ – selling up everything it owns to pay its debts.
What is cash inflow
are the sums of money received by a business during a period of time.
Common sources of cash inflow
» The sale of products for cash.
» Payments made by debtors – debtors are customers who have already purchased products from the business but did not pay for them at the time.
» Borrowing money from an external source – this will lead to cash flowing into the business (it will have to be repaid eventually).
» The sale of assets of the business, for example, unwanted property.
» Investors, for example, shareholders in the case of companies, putting more money into the business.
What is cash outflow
The sums of money paid out by a business during a period of time.
Common sources of cash outflow
» Purchasing goods or materials for cash.
» Paying wages, salaries and other expenses in cash.
» Purchasing non-current (fixed) assets.
» Repaying loans.
» By paying creditors of the business – other firms which supplied items to the business but were not paid immediately
What is the cash flow cycle
shows the stages between paying out cash for labour,
materials, and so on, and receiving cash from the sale of goods.
What is profit
Surplus revenue after costs have been deducted
relation between closing cash and opening cash
The closing cash of a particular month becomes the opening cash of the consecutive month
What is a cash flow forecast
is an estimate of future cash inflows and outflows of
a business, usually on a month-by-month basis. This then shows the expected cash balance at the end of each month
What can a cash flow forecast tell the manager
» how much cash is available for paying bills, repaying loans or for buying fixed assets
» how much cash the bank might need to lend to the business in order to avoid insolvency
» whether the business is holding too much cash which could be put to a more profitable use (eg: advertising, R&D, new machinery, etc).
when is a cash flow forecast used
» starting up a business
» running an existing business
» keeping the bank manager informed
» managing cash flow.
What is the Net Cash flow
is the difference, each month, between inflows and
outflows.
= Cash Inflow - outflow
What is Closing Cash
the amount of cash held by the business at the end of each month. Becomes next month’s opening balance
What is Opening Cash
Amount of cash held by a business at the start of a month
How can a profitable business run out of cash
• allowing customers too long a credit period, perhaps to encourage sales
• purchasing too many non-current (fixed) assets at once
• expanding too quickly and keeping a high inventory level which requires cash
Short term methods of overcoming cashflow problems
> increasing bank loans
delaying payments to suppliers
asking debtors to pay more quickly/asking for cash only sales
delay or cancel the purchases of capital equipment
Increasing bank loans
how it works and drawbacks
Bank loans will inject more cash into the business
disadv:
Interest has to be paid - reduces profit
Loans will have to be paid eventually - a cash outflow
Delaying payments to suppliers
how it works and drawbacks
Cash outflows will decrease in the short term
disadv:
Suppliers could refuse to supply
Suppliers could offer lower discounts for late payments
asking debtors to pay more quickly/asking for cash only sales
how it works and drawbacks
Cash inflows will increase in the short term
disadv:
Customers may purchase from another business that
still offers them time to pay (trade credit)
Delay or cancel purchases of capital equipment
how it works and drawbacks
Cash outflows for purchase of equipment will decrease
disadv:
The long-term efficiency of the business could decrease without up-to-date equipment
Long term methods to solve cashflow problems
» Attracting new investors, for example, by selling more company shares – but will this affect ownership of the business?
» Cutting costs and increasing efficiency – but will this be popular with employees and could product quality be affected?
» Developing new products that will attract more customers – this could take a long time and needs cash in the short term to pay for development.
What is working capital
formula
the capital available to a business in the short term to pay for day-to-day expenses.
Current assets - current liabilities
What are current assets
what are current liabilities
Current assets - assets that can be converted to cash within 1 year
Current liabilities - amounts due to creditors within 12 months
Different forms of working capital
» Cash is needed to pay day-to-day costs and buy inventories.
» The value of a firm’s debtors is related to the volume of production and sales. To achieve higher sales there may be a need to offer additional credit facilities.
» The value of inventories is also a significant part of working capital. Not having enough inventories may cause production to stop. On the other hand, a very
high inventory level may result in high opportunity costs
What is overtrading
Keeping higher inventory levels which may use a lot of cash.
