Chapter 23: Cashflow forecasting and working capital

Question 1

What is cash flows

Answer 1

The business’s cash inflows and outflows over a period of time

Question 2

Problems because of a lack of cash flow

Answer 2

» 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.

Question 3

What is cash inflow

Answer 3

are the sums of money received by a business during a period of time.

Question 4

Common sources of cash inflow

Answer 4

» 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.

Question 5

What is cash outflow

Answer 5

The sums of money paid out by a business during a period of time.

Question 6

Common sources of cash outflow

Answer 6

» 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

Question 7

What is the cash flow cycle

Answer 7

shows the stages between paying out cash for labour,
materials, and so on, and receiving cash from the sale of goods.

Question 8

What is profit

Answer 8

Surplus revenue after costs have been deducted

Question 9

relation between closing cash and opening cash

Answer 9

The closing cash of a particular month becomes the opening cash of the consecutive month

Question 10

What is a cash flow forecast

Answer 10

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

Question 11

What can a cash flow forecast tell the manager

Answer 11

» 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).

Question 12

when is a cash flow forecast used

Answer 12

» starting up a business
» running an existing business
» keeping the bank manager informed
» managing cash flow.

Question 13

What is the Net Cash flow

Answer 13

is the difference, each month, between inflows and
outflows.

= Cash Inflow - outflow

Question 14

What is Closing Cash

Answer 14

the amount of cash held by the business at the end of each month. Becomes next month’s opening balance

Question 15

What is Opening Cash

Answer 15

Amount of cash held by a business at the start of a month

Question 16

How can a profitable business run out of cash

Answer 16

• 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

Question 17

Short term methods of overcoming cashflow problems

Answer 17

> 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

Question 18

Increasing bank loans
how it works and drawbacks

Answer 18

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

Question 19

Delaying payments to suppliers
how it works and drawbacks

Answer 19

Cash outflows will decrease in the short term

disadv:
Suppliers could refuse to supply
Suppliers could offer lower discounts for late payments

Question 20

asking debtors to pay more quickly/asking for cash only sales

how it works and drawbacks

Answer 20

Cash inflows will increase in the short term

disadv:
Customers may purchase from another business that
still offers them time to pay (trade credit)

Question 21

Delay or cancel purchases of capital equipment

how it works and drawbacks

Answer 21

Cash outflows for purchase of equipment will decrease

disadv:
The long-term efficiency of the business could decrease without up-to-date equipment

Question 22

Long term methods to solve cashflow problems

Answer 22

» 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.

Question 23

What is working capital
formula

Answer 23

the capital available to a business in the short term to pay for day-to-day expenses.

Current assets - current liabilities

Question 24

What are current assets
what are current liabilities

Answer 24

Current assets - assets that can be converted to cash within 1 year

Current liabilities - amounts due to creditors within 12 months

Question 25

Different forms of working capital

Answer 25

» 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

Question 26

What is overtrading

Answer 26

Keeping higher inventory levels which may use a lot of cash.