Chapter 30 Forecasting and managing cashflow

Question 1

How to forecast cash inflows:

Answer 1

1. Owners own capital injection: This falls under the owners own control
2. Bank loan payments: This would be agreed upon by the bank
3. bit more difficult to forecast because you wont know how many will buy cash and how many on credit
4. Debtors payments: two unknowns; you wont know how many will buy on credit and you wont know if and when they will pay

Question 2

How to forecast cash outflows:

Answer 2

1. Lease payments for premises; easy as this is in the contract
2. Annual rent payment; this will also be fixed and agreed upon
3. Electricity and gas, water and telephone bills; difficult to forecast as they vary every month
4. Labour cost payments; will depend on demand forecasts and hourly wage rates to be paid.
5. Variable cost payments; this should vary consistently with demand in other words this will vary according to revenue forecasts.

Question 3

Benefits of cash flow forecasting

Answer 3

• They show negative closing cash flows. This means that plans can be made to source additional finance, such as a bank overdraft or the injection of more capital from the owner.
• They indicate periods of time when negative net cash flows are excessive. The business can plan to reduce these by taking measures to improve cash flow
• They are essential to all business plans. A business start-up will never gain finance unless investors and bankers have access to a cash flow forecast and the assumptions behind it.

Question 4

Limitations of cash flow forecasting

Answer 4

• Mistakes can be made in preparing the revenue and cost forecasts, or they may be drawn up by inexperienced entrepreneurs or staff.
• Unexpected cost increases lead to major inaccuracies in forecasts.
• Incorrect assumptions can be made in estimating the sales of the business, perhaps based on poor market research. This will make the cash inflow forecasts inaccurate.

Question 5

Causes of cash flow problems

Answer 5

1. Lack of planning: planning is essential to predict potential cash flow problems so that the managers have plenty of time to overcome the
   problems
2. Poor credit control: If credit control is inefficient or badly managed, then debtors will not be chased up to pay their debts and potential bad debt will not be identified.
3. Allowing customers too long to pay debts: It is sometimes necessary to allow credit to be competitive, however, allowing them too long time to pay their debt could lead t o cash flow problems.
4. Expanding too rapidly: All expansions have to be paid before increased sales can fill the cash register. This can lead to serious cash flow shortages.
5. Unexpected events: A break down of a delivery van that needs to be replaced, or a dip in predicted sales income or a competitor lowering his prices unexpectedly could lead to negative net cash flows

Question 6

Increase cash inflows - Ways to improve cash flow

Answer 6

Overdraft
» A flexible source of cash from a bank which a business can draw on as necessary up to an agreed limit.
* Interest rates can be high and there may be an arrangement fee.
* Overdrafts can be withdrawn by the bank, which often causes insolvency.

Short-term loan
» A fixed amount can be borrowed for an agreed length of time.
* The interest costs have to be paid.
* The loan must be repaid by the due date.

Sale of assets
» Cash receipts can be obtained
from selling off redundant assets, which will boost cash inflow.
* Selling assets quickly can result in a low price.
* The assets might be required at a later date for expansion.
* The assets could have been used as collateral for future loans.

Sale and leaseback
» Assets can be sold (for example to a finance company), but the assets can be leased back from the new owner.
* The leasing costs add to annual overheads.
* There could be loss of potential profit if the assets rise in price.
* The assets could have been used as collateral for future loans.

Manage trade receivables
* Not extending credit to customers or asking customers to pay more quickly = pressure = may not buy again = customers expect credit
* Selling claims on trade receivables to specialist financial institutions called debt factors = loss in cash as they wont pay 100%
* Finding out whether new customers are creditworthy = by finding out from bank or using services of a credit enquiry agency
* Offering a discount to customers who pay promptly = discounts reduces profit margin

Question 7

Reduce cash outflows - Ways to improve cash flow

Answer 7

Delay capital expenditure
» By not buying equipment, vehicles etc. cash will not have to be paid to suppliers.
* The efficiency of the business may
fall if inefficient equipment is not
replaced.
* Expansion becomes very difficult.

Use leased equipment
» The leasing company owns the asset and no large cash outlay is required.
* The asset is not owned by the
business.
* Leasing charges include an interest cost and add to annual overheads.

Cut overhead cots that don’t directly affect output (eg promotion costs)
» These costs will not reduce production capacity and cash outflows will be reduced.
* Future demand may be reduced by failing to promote the products
effectively.

Manage trade payables
* Purchasing more supplies on credit and not cash = if poor credit rating this won’t be easy = miss out on cash discounts
* Extend the period of time taken to pay = Suppliers won’t supply unless paid