forecasting and managing cash flows

Question 1

Cash flow:

Answer 1

the sum of cash payments to a business (inflows) less the sum of cash payments (outflows).

Question 2

Liquidation

Answer 2

when a firm ceases trading and its assets are sold for cash to pay suppliers and other creditors.

Question 3

Insolvent:

Answer 3

: when a business cannot meet its short-term debts.

Question 4

Cash-flow planning is vital for entrepreneurs because:

Answer 4

■ new business start-ups are often offered much less time to pay suppliers than larger, well-established firms– they are given shorter credit periods
■ banks and other lenders may not believe the promises of new business owners as they have no trading record, they will expect payment at the agreed time
■ finance is often very tight at start-up, so not planning accurately is of even more significance for new businesses

Question 5

Cash inflows

Answer 5

payments in cash received by a business, such as those from customers (trade receivables) or from the bank, e.g. receiving a loan

Question 6

Cash outflows

Answer 6

payments in cash made by a business, such as those to suppliers and workers.

Question 7

some example cash inflows and how they might be forecast:

Answer 7

■ Owner’s own capital injection: This will be easy to forecast as this is under Mohammed’s direct control.
■ Bank loan payments: These will be easy to forecast if they have been agreed with the bank in advance, both in terms of amount and timing.
■ Customers’ cash purchases: These will be difficult to forecast as they depend on sales, so a sales forecast will be necessary– but how accurate might this be?

Question 8

some example cash outflows and how they might be forecast:

Answer 8

■ Lease payment for premises– easy to forecast as this will be in the estate agent’s details of the property.
■ Annual rent payment– easy to forecast as this will be fixed and agreed for a certain time period. The landlord may increase the rent after this period, however.
■ Electricity, gas, water and telephone bills– difficult to forecast as these will vary with so many factors, such as the number of customers, seasonal weather conditions and energy prices.

Question 9

The structure of cash-flow forecasts

Answer 9

Section 1– Cash inflows This section records the cash payments to the business, including cash sales, payments for credit sales and capital inflows
Section 2– Cash outflows: This section records the cash payments made by the business, including wages, materials, rent and other costs
Section 3– Net monthly cash flow and opening and closing balance: This shows the net cash flow for the period and the cash balances at the start and end of the period

Question 10

Cash-flow forecasting most common limitations of them

Answer 10

■ 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 can lead to major inaccuracies in forecasts. Fluctuations in oil prices can lead to the cash-flow forecasts of even major airlines being misleading.
■ Wrong assumptions can be made in estimating the sales of the business, perhaps based on poor market research, and this will make the cash inflow forecasts inaccurate.

Question 11

The causes of cash-flow problems

Answer 11

1. Lack of planning
2. Poor credit control
3. Allowing customers too long to pay debts
4. Expanding too rapidly

Question 12

Overtrading

Answer 12

expanding a business rapidly without obtaining all of the necessary finance so that a cash-flow shortage develops.

Question 13

Ways to improve cash flow

Answer 13

1 increase cash inflows

2 reduce cash outflows

Question 14

Trade receivables can be managed in many different ways

Answer 14

■ Not extending credit to customers– or extending it for shorter time periods
■ Selling claims on trade receivables to specialist financial institutions acting as debt factors
■ By being careful to discover whether new customers are creditworthy

Question 15

Credit from suppliers can be managed in two main ways

Answer 15

1 Increasing the range of goods and services bought on credit: If a business has a good credit rating, this may be easy,
2 Extend the period of time taken to pay: The larger a business is, the easier it is to extend the credit taken but in other circumstances it is difficult. Evaluation of this approach

Question 16

Inventory can be managed in the following ways:

Answer 16

■ keeping smaller inventory levels
■ using computer systems to record sales– and, therefore, inventory levels– and ordering as required
■ efficient inventory control, inventory use and inventory handling so as to reduce losses through damage, wastage and shrinkage

Question 17

Cash can be managed by:

Answer 17

■ use of cash-flow forecasts– as identified above, these can help the management of cash flows and working capital needs
■ wise use or investment of excess cash

Question 18

analyse working capital

Answer 18

■ There is no ‘correct’ level of working capital for all businesses. Business requirements for working capital will depend on a number of factors, especially the length of the working capital cycle. For example, supermarkets can manage on a much lower level of working capital than a shipbuilding business.
■ Too much liquidity is wasteful.
■ Too little liquidity can lead to business failure.