Chapter 31- cash flow and working capital

Question 1

When does cash come into the business?

Answer 1

• sales
• borrowing (inflows)

Question 2

When does cash leave the business?

Answer 2

• materials
• labour
• marketing
• interest payments on loans (outflows)

Question 3

What will happen without cash?

Answer 3

• wages can’t be paid
• loans can’t be repaid
• raw materials can’t be bought (no business without these inputs)

Question 4

How does cash flow differ from profit?

Answer 4

• cash flow considers the inflows and outflows of cash for a business whereas profit is a measure based on the difference between revenue and costs
• if a business has a negative cash flow it doesn’t mean it has a negative profit

Question 5

What happens before the inflows are received for many businesses?

Answer 5

• outflows occur before the inflows are received
• businesses can run out of cash and subsequently go into liquidation

Question 6

What are cash flow forecasts?

Answer 6

• they are estimates of the likely inflows and outflows of cash into and out of the business over a given period of time
• forecasts shows the amount of cash that will flow in and out and the likely timing of such inflows and outflows

Question 7

What are cash flow statements?

Answer 7

• they are the actual figures produced once transactions have occurred

Question 8

Reasons for cash flow forecasts

Answer 8

• preparing a cash flow forecast is a valuable planning procedure. It allows the business to put into place strategies to deal with any forecasted negative cash flow such as organising a loan or an extension to its overdraft facilities
• the forecast is useful for helping the business to set its prices
• if the forecasted sales revenue is low the marketing team may consider promotional pricing in order to boost sales revenue
• cash flow forecasts are looked at by potential investors. Venture capitalists and potential shareholders will be interested in the figures in order to assess its likelihood of success
• suppliers may want to see figures to assess if the business will be able to pay for the supplies on time
• managers of the business will use the cash flow information to monitor the business and react accordingly

Question 9

Where are the figures for the cash flow forecasts and statements usually shown and why?

Answer 9

• each month of the year
• because it will allow the business to see its cash flows throughout all the trading period
• may be seasonal variations in sales
• more accurate and reliable to show forecasts for all months

Question 10

What is important to remember if the loan is a positive flow (inflow)?

Answer 10

• that there will be a need to be outflows to pay back the loan with interest payments

Question 11

Total inflows

Answer 11

• the addition of all inflows into the business (positive)

Question 12

Utilities

Answer 12

• includes costs for gas, electricity, telephones and water

Question 13

Total outflows

Answer 13

• aggregate of all the outflows (negative)

Question 14

Net cash inflow

Answer 14

• cash inflows - cash outflows

Question 15

Closing balance

Answer 15

• the final figure
• will be carried forward as the opening balance for the next month

Question 16

What could contribute to the negative cash flow?

Answer 16

• stock purchases are excessive
• too much money is tied up in stock

Question 17

Interpreting data (table 31.1 from book)

Answer 17

• Only first 6 months of the year have been given so if the product is seasonal it wont show a true overall picture of the cash flow of the business
• doesn’t give any indication of how long the business has been trading
• source of sales revenue is just a total and gives no indication whether its from one or several products
• type of business is not given so may be difficult to judge the significance of the cash flow forecast
• no indication of what is happening to prices (inflation) within the period of the forecast

Question 18

What can the falling level of sales revenue be due to?

Answer 18

• its different depending on the type of business and the state of the economy

Could be due to:
- seasonal change e.g. ski holidays
- business faced with recession- due to lack of demand, business involved with a luxury product
- decline stage

Question 19

Changes to the interest rate

Answer 19

• consequences of such low interest rates for businesses could mean a much lower level of costs in terms of repayments on overdrafts and loans
• but its likely that the interest on loans will have been fixed when the loan was taken out

Question 20

Changes in economic policy

Answer 20

• can have a significant effect on cash flow forecasts
• increases in taxation and national insurance contributions all affect the disposable income of consumers and their ability to purchase products
• sales revenue forecasts can swiftly appear too optimistic or pessimistic

Question 21

Changes in the economic climate

Answer 21

• can affect a business very quickly

Question 22

Forecasts are estimates

Answer 22

• has no certainty as to how potential consumers will respond in purchasing its products
• time of the year in which the business is launched will influence the forecast
  E.g. forecast for sales may be higher for the Christmas period

Question 23

Forecasting seasonal demand

Answer 23

• gauging demand for seasonal products is difficult
  E.g. ice cream, soft drinks, alcohol, barbeques are all examples of goods that may be dependant upon the weather in the UK

Question 24

World events

Answer 24

• can have a dramatic effect on cash flow forecast
  E.g. earthquakes, floods, tsunamis, plane crashes
• all of these events can and have greatly affected sales revenues

Question 25

Competitors behaviour

Answer 25

- how competitors act and react can also have an effect on the accuracy of any cash flow forecast - if competitors reduce their prices this may affect the sales revenue of another business - a business may respond to competitor price changes with its own price changes which in turn affect sales revenue - to what extent sales revenue will be affected will depend upon the elasticity of the product/ serve and the degree of competition within the market

Question 26

Changes in technology

Answer 26

- may affect sales revenue and costs - competitors may launch a technologically superior product which makes the businesses products inferior and therefore leads to a rapid fall in sales revenue - business may need to respond by launching its own updated product in order to compete resulting in higher investment and marketing costs to compete in the market place

Question 27

What can planning help with?

Answer 27

- it can help alleviate problems in the future

Question 28

Impact of cash flow forecasts and statements on a business

Answer 28

- used as a measure of performance - management are able to monitor by comparing the forecast with the statement - they allow management to correct any problems that may occur - employees may be able to judge the ability of the business to offer high levels of pay - potential lenders may ask to see forecasts to assess viability of business to be able to repay any such loans

Question 29

Causes of cash flow problems

Answer 29

Level of sales - if a sudden fall in the level of sales revenue coincides with a heavy period of payments that are due, a negative cash flow may be inevitable Business environment - change in business environment caused by a range of factors such as ethical issues or new legislation may lead to a fall in sales and an increase in costs - changes in health and safety legislation may lead to additional costs for businesses which have to implement the new laws and may face additional costs of safety equipment and further training for its employees Excess stock - holding too much stock is a cost burden - if a large amount of stock are held in the factory, costs have been incurred without revenue being received - it is a negative cash flow - may be one of the reasons why businesses have adopted the just in time system of production (JIT) in order to reduce stock levels and therefore the amount of cash outflows Late payments from debtors (receivables) - any delay in payments by the debtors of a business will have a negative effect on the cash flow - offering delays to such payments is often used as a marketing ploy by businesses to gain trade Paying creditors too quickly - in some ways its better to delay payment to the creditors of the business - but there may be a delay in receiving attention to problems with supplies if payment to the suppliers (creditors) are delayed Over trading - cost of such expansion is often greater than the present level of sales and therefore is a negative cash flow Holding the right amount of cash (working capital) - amount of cash held by the business will depend upon the nature of the business

Question 30

Liquidity ratios

Answer 30

- use of these such as current ratio and acid test are simple ways to assess the level of cash within a business Too little cash - creates an inability to meet creditors requests for payment. May mean it becomes difficult to buy stock or raw materials - e.g. bank consequences of not paying can be more serious as any loans may then be foreclosed - lack of cash may mean that additional funds will need to be borrowed from the bank possibly at higher rates of interest Too much cash - wasted opportunity to purchase more stock - may be a loss of interest if the excess cash was not put into an account

Question 31

Improving the cash flow of the business

Answer 31

Increase sales - in the short term there will be additional cash outflows to pay for the marketing needed to increase sales - increased sales may only be achieved by reducing the price Reduce stock levels by selling off stock or buying less stock - utilisation of JIT will reduce the level of stock held - by holding less stock the cost of storage and the time gap between the usage of stock and the sales revenue may be reduced Factoring - it is the selling of the debts of a business Leasing not buying - form of borrowing - similar to renting but ownership isn’t gained - amount of cash required is less Loans - means that a large amount of capital is not required in one sum to pay for the required machine or building - in the long run it is more costly because of the interest that has to be paid Changing creditor and debtor days - to improve the liquidity of the business, the number of debtors could be reduced - cash would flow into the business much sooner - creditor days could be increased - delaying payment to creditors will allow cash to remain within the business for a longer period of time Cut operating costs - outsourcing - may cost more to outsource - on the other hand, there may be an opportunity to reduce overheads and therefore reduce outflows