forecasting and managing cash flows chapter 30 Flashcards
cash flow
the sum of cash payments to a business less the sum of cash payments from the business
insolvent
when a business cannot meet its short term debts
cash flow forecast
an estimate of the future cash inflows and outflows of a business
what is the purpose of a cash flow forecast
for a business to survive, having sufficient cash to pay suppliers, banks and employees is an important factor. even if a business with high revenue and low expenses it could still lead to negative cash flow. without positive cash flow, any company-no matter how promising its business model- will become insolvent and bankrupt.
why are cash flow forecasts important for entrepreneurs starting new businesses
new business start ups are often offered much shorter credit to pay suppliers than larger firms. banks and other lenders will need to see evidence of a cash flow forecast before making any finance available. finance is often very tight at start up, so accurate planning is much more significant for new businesses
what is the meaning of forecasting cash flow
it means to trying to estimate future cash inflows and cash outflows, usually on a month by month basis
cash inflow
cash payments into a business
cash outflow
cash payments out of a business
structure of a cash flow forecast
it is typically constructed monthly, often for the next 12 months, but it can cover a shorter time period. it has three sections which are cash inflows, cash outflows, net cash flow and opening and closing balance.
net cash flow
estimated difference between cash inflows and cash outflows for the period
opening cash balance
cash held by the business at the start of the month
closing cash balance
cash held by the business at the end of the month, which becomes the next month’s opening balance
section of cash flow forecasts: cash inflows
this section records the cash payments to the business, including cash sales, payments for credit sales, and capital inflows
section of cash flow forecasts: cash outflows
this section records the cash payments made by the business, including wages, materials, rent and other costs
section of cash flow forecasts: net 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 and the cash balances at the start and end of the period (the opening and closing balance). if the closing balance is negative (shown by a figure in brackets), then a bank overdraft will almost certainly be necessary to finance this
formula of the the closing cash balance
opening cash balance + (cash inflows - cash outflows)
this closing balance becomes the opening balance for the next month
benefits of cash flow
they show negative cash flow which means that plans can be made to source additional finance
they indicate periods of time when negative net cash flows are excessive so that the business can plan to reduce these by taking measuring to improve cash flow
they are essential to all business plans because a business start up will never gain finance unless investors and bankers have access to a cash flow forecast and the assumption behind it
limitations of cash flow forecasting
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.
causes of cash flow problems
there are several causes of cash flow problems like lack of planning, poor credit control, allowing customers too long to pay debts, expanding too rapidly and unexpected events
causes of cash flow problems: lack of planning
cash flow forecasts help in predicting future cash problems for a business and financial planning can be used to predict potential cash flow problems so that managers can take action to overcome them in plenty of time. some businesses have insufficient plans for cash flow management.
causes of cash flow problems: poor credit control
if credit control is badly managed, then trade receivables will not be chased for payment and potential bad debts will not be identified
credit control
monitoring of debts ensure that credit periods are not exceeded. the credit control department of a business keeps a check on all customers’ accounts. they record who has paid, who is paying on time and which customers are not paying on time
bad debt
unpaid customers’ bills that are now very unlikely to be ever paid
overtrading
expanding a business rapidly without obtaining all of the necessary finance, resulting in a cash flow shortage
causes of cash flow problems: allowing customers too long to pay debts
many businesses have to offer trade credit to customers in order to be competitive. a customer may choose product that allow trade credit because this improves their cash flow. allowing customer too long to pay reducing short term cash inflows, which leads to cash flow problems.
causes of cash flow problems: expanding too rapidly
when a business expands rapidly, it has to pay for the expansion and for increased wages and materials months before it receives cash from additional sales. this overtrading can lead to serious cash flow shortages even though the business is successful and expanding
causes of cash flow problems: unexpected events
unforeseen increases in costs and could lead to negative net cash flows not being indicated on the original cash flow forecast. factors such as the breakdown of the delivery truck can make the original cash flow forecast inaccurate
methods of improving cash flow
cash flow can be improved by increasing cash inflows or reducing cash outflows. care needs to be taken here. the aim is to improve the cash position of the business, not revenue or profit
method of increasing cash inflow: overdraft
a flexible sources of cash from a bank which a business can draw on as necessary up to an agreed limit
method of increasing cash inflow: short term loan
a fixed amount can be borrowed for an agreed length of time
method of increasing cash inflow: sale of assets
cash receipts can be obtained from selling off redundant assets, which will boost cash inflow
method of increasing cash inflow: sale and leaseback
assets can be sold, but the assets can be leased back from the new owner
method of reducing cash outflow: delay capital expenditure
by not buying equipment, vehicles etc. cash will not have yo be paid by suppliers
method of reducing cash outflow: use leasing, not outright purchase, of capital equipment
the leasing company owns the asset and no large cash outlay is required
drawback of overdraft to increase cash inflows
Interest rates can be high and there may be an arrangement fee.
Overdrafts can be withdrawn by the bank, which often causes insolvency.
drawback of short term loan to increase cash inflows
The interest costs have to be paid.
The loan must be repaid by the due date.
drawback of sale of assets to increase cash inflows
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.
drawback of sale and leaseback to increase cash inflows
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.
drawbacks of delay capital expenditure to reduce cash outflows
The efficiency of the business may fall if inefficient equipment is not replaced.
Expansion becomes very difficult.
drawbacks of using leasing, not outright purchase, of capital equipment to reduce cash outflows
The asset is not owned by the business.
Leasing charges include an interest cost and add to annual overheads.
improving cash inflow by managing trade receivables
ways trade receivables can be managed to improve cash inflow are by not extending credit, to customers or asking customers to pay more quickly, selling claims on trade receivables to specialist financial institutions called debt factors, finding out whether new customers are credit worthy or offering a discount to customers who pay monthly
improving cash inflow by managing trade receivables: not extending credit, to customers or asking customers to pay more quickly
Many customers now expect credit and will go elsewhere if it is not offered. The marketing department might argue for an increase in credit terms to customers at the same time as the finance department is trying to cut down on them.
improving cash inflow by managing trade receivables: selling claims on trade receivables to specialist financial institutions called debt factors
These businesses will buy debts from other concerns that have an immediate need for cash. This will involve a cost, however, as the debt factors will not pay 100% of the value. They must make a profit for themselves.
improving cash inflow by managing trade receivables: finding out whether new customers are credit worthy
This can be done by requiring references, either from traders or from the bank, or by using the services of a credit enquiry agency.
improving cash inflow by managing trade receivables: offering a discount to customers who pay monthly
Although cash might be paid quickly, discounts reduce the profit margin on a sale.
method of reducing cash outflow: Cut overhead costs that do not directly affect output
These costs will not reduce production capacity and cash outflows will be reduced.
drawbacks of Cutting overhead costs that do not directly affect output in reducing cash outflows
Future demand may be reduced by failing to promote the products effectively.
ways in which cash outflow can be reduced by managing trade payables
it can be reduced by purchasing more supplies on credit and not cash or extending the period of time taken to pay
ways in which cash outflow can be reduced by managing trade payables: purchasing more supplies on credit and not cash
If a business has a good credit rating, this may be easy, but in other circumstances it can be difficult. Discounts from suppliers for quick cash payment might be stopped. Some suppliers might refuse to offer credit terms.
ways in which cash outflow can be reduced by managing trade payables: extending the period of time taken to pay
The larger a business is, the easier it is to insist on longer credit periods from suppliers. This will improve the business’s cash flow. Slow payment by larger businesses is often a great burden for the small businesses that supply them. Suppliers may be reluctant to supply products or to offer a good service if they consider that a business is a late payer.
