Learning Outcome E: Break-even and cash flow forecasts Flashcards
Cash flow forecast
A document that shows the predicted flow of cash into and out of a business over a given period of time, normally 12 months
Cash flows into and out of a business on a _______ basis
regular
What does a cash flow forecast try to predict?
What and when cash flows will be in advance
True/False: Having a healthy cash flow is crucial to the survival of a business
True
What does a healthy cash flow mean for a business?
It will have enough cash at any one point in time to be able to meet demand for short-term cash outflows
By forecasting cash flow in advance, a business can…
identify where there might be shortages and either try to prevent this from happening or put plans in place to deal with it
Cash inflows or receipts
Money coming into the business from various sources
Cash sales
The customer pays at the time of purchase
Credit sales
The customer pays in a pre-agreed period after the sale, for example 30 days
Loans
Bank loans to fund the purchase of assets such as machinery and vehicles
Capital introduced
Money invested from entrepreneurs or shareholders when a business is first set up or looks to expand
Sale of assets
The sale of items owned by the business which are no longer needed in order to bring a short-term cash injection into the business
Bank interest received
Interest paid by the bank on credit balances
Cash outflows or payments
The money going out of the business for various purposes
Cash purchase
Items purchased by a business and paid for at the time of purchase
Credit purchases
Items purchased by a business and paid for at a later point in time
Purchase of assets
Non-current assets that a business is likely to keep for more than one year such as machinery and vehicles
What does VAT stand for?
Value Added Tax
Business that are VAT registered must pay ___, and this should be…
VAT, shown in cash flow forecast
Give 4 examples of inflows/receipts
Any 4 from cash sales, credit sales, loans, capital introduced, sale of assets and bank interest received
Give 6 examples of outflows/payments
Any 6 from cash purchase, credit purchases, purchase of assets, VAT, bank interest paid, rent, rates, salaries, wages and utilities
Cash sales is an example of an inflow/outflow
inflow
Credit sales is an example of an inflow/outflow
inflow
Loans are an example of an inflow/outflow
inflow
Capital introduced is an example of an inflow/outflow
inflow
Sale of assets is an example of an inflow/outflow
inflow
Bank interest received is an example of an inflow/outflow
inflow
Cash purchase is an example of an inflow/outflow
outflow
Credit purchases are an example of an inflow/outflow
outflow
Purchase of assets is an example of an inflow/outflow
outflow
VAT is an example of an inflow/outflow
outflow
Bank interest paid is an example of an inflow/outflow
outflow
Rent is an example of an inflow/outflow
outflow
Rates are an example of an inflow/outflow
outflow
Salaries are an example of an inflow/outflow
outflow
Wages are an example of an inflow/outflow
outflow
Utilities are an example of an inflow/outflow
outflow
A business with sales in excess of the VAT threshold must register itself with ____ and then record…
HMRC, VAT received on sales and paid on purchases.
After recording VAT received on sales and paid on purchases a business must then work out…
whether it has paid or received more money in VAT, then claim a refund or make a payment as appropriate
What must a business do if it works out that it has paid more money than it has received in VAT?
Claim a refund
What must a business do if it works out that it has received more money than it has paid in VAT?
Make a payment
Opening balance
The amount of cash available in a business at the start of a set time period, for example a month
Closing balance
The amount of cash available in a business at the end of a set time period, for example a month
What does a cash flow forecast show?
Opening balance, cash in , cash out and closing balance
A cash flow forecast is normally shown on a _______ basis
monthly
A cash flow forecast is usually drawn up for how big of a period?
A 12-month period
The closing balance at the end of January becomes the opening balance at…
the start of February
Credit period
The length of time given to customers to pay for goods or services
Credit periods have how many major influences on a business’ cash flow?
2
The longer a credit period, the…
the slower the money coming in will be
A business must consider how long it gives its customers to pay. If it accepts ____ sales only, then this will not be a concern
cash
If a greengrocer gives one month’s credit for a sale made in January, they will…
not see cash flowing into the business until February
True/False: Credit periods affect the ability of a business to gain credit from its suppliers
True
If a business can secure supplies on credit what effect will this have on the flow of cash out of a business?
Will slow it down
The longer the credit period, the sooner/later the cash flows out
later
True/False: Some businesses can secure credit periods of 30, 60 or even 90 days
True
If a business both sells on credit to its customers and buys on credit from its suppliers, it needs the first to have a shorter/longer credit period than the second
shorter
True/False: The opening balance at the start of the year will be a true reflection of the business’ bank balance
True
True/False: The closing balance at the end of the year will be a true reflection of the business’ bank balance
False, this is based upon predicted incomes and expenditures over the period of the cash flow forecast, normally a year
What is the closing balance at the end of a year in a cash flow forecast based upon?
Predicted incomes and expenditures over the period of the cash flow forecast, normally a year
One of the key purposes of the cash flow forecast is to highlight, in advance, any…
months where there is a risk of a negative cash flow, as this allows the business to make arrangements such as a prearranged overdraft with the bank or try to take actions to avoid this
What may a business want to do if they see there is a month with a risk of a negative cash flow?
Make arrangements such as a prearranged overdraft with the bank, or try to take actions to avoid this
A business with a negative closing balance is often said to have _________ problems and is in danger of becoming _________
liquidity, insolvent
Liquidity
Measures a firm’s ability to meet short-term cash payments
Insolvent
When a firm is unable to meet short-term cash payments
A cash flow forecast can help to identify where there are potential what?
Shortfalls
True/False: A cash flow forecast can indicate where there are large amounts of cash left at the end of a month of year
True
True/False: A large amount of cash being left at the end of a month for a business is always a good thing
False, this may be an indication that the business is not taking advantage of opportunities
Why should the actual cash flow of a business be monitored alongside a cash flow forecast?
To see if inflows and outflows are as expected, better or worse
When do problems occur with cash flows?
When the business’s outflows are greater than the opening balance plus the inflows
Why is it a problem when a business’s outflows are greater than the opening balance plus the inflows?
This will result in a negative closing balance
Having a negative closing balance means that a business will not…
have enough cash to meet payments that are due
True/False: Most businesses have consistent cash flows throughout the year
False, very few businesses do. They are likely to experience busy and quiet times
The cash flow cycle
Fluctuations in the cash flow of a business - as a result of busy and quiet periods
Businesses in which industry are likely to have the largest fluctuations in cash flow?
The seasonal industry
Someone who owns a small bed and breakfast in a seaside town will have to pay costs like what all year round?
Rent, heat and light, insurance and bank charges, etc.
What additional costs to rent, heat and light, insurance, etc. would there be for a small bed and breakfast during season?
Wages and stock
Give 2 examples of solutions to cash flow problems that a business can implement
Any 2 from overdraft arrangements, negotiating terms with creditors and reviewing and rescheduling capital expenditure
Overdraft arrangements
A business with a fluctuating cash flow cycle should be able to show the forecast to the bank and make arrangements for periods of negative cash flows. Banks sometimes offer free overdraft facilities to help businesses through these periods, but only if pre-agreed. Going overdrawn on a bank account without an agreement with the bank can be a very expensive option
A business with a fluctuating cash flow cycle should be able to show the forecast to the bank and…
make arrangements for periods of negative cash flows
True/False: Banks sometimes offer free overdraft facilities to help businesses go through periods of cash flow problems
True, but only if pre-agreed
What’s the drawback of going overdrawn on a bank account without an agreement with the bank?
This can be a very expensive option
Negotiating terms with creditors
A business with cash flow problems could try to negotiate a longer payment term with its suppliers, e.g. an increase from 30 days to 60 days in order to slow down the flow of cash out of the business
Creditors
Creditors are people or businesses that a business owes money to, normally because goods or services have been bought on credit as opposed to cash purchases
What’s the downside to negotiating a longer payment term with a creditor?
You may lose any discounts offered for prompt or early repayment
Reviewing and rescheduling capital expenditure
Having identified cash flow problems, the owner or manager could review what cash outflows were being spent on. Such a review might identify areas of expenditure that could be cut or postponed. It is difficult to do this if the expenditure is on revenue items - for example, replacement stock - but more achievable if it is capital expenditure. A business could, for example, postpone plans to replace machinery or buy a new van
Having identified cash flow problems, the owner or manager could review what cash outflows were being spent on. Such a review might identify areas of expenditure that…
could be cut or postponed
It is easier to cut or postpone expenditure of revenue items/capital expenditure
capital expenditure
Give an example of capital expenditure that a business may consider cutting or postponing to ensure a healthy cash flow
Any from postpone plans to replace machinery or buy a new van, etc.
What is the alternative to buying capital equipment outright?
Leasing it
Although leasing capital equipment can prove expensive in the long run, it means that rather than…
paying in one lump sum, the business can pay to use it on a monthly basis
Give 3 advantages of cash flow forecasts
Any 3 from encourages planning for cash inflows and outflows, enables cash flow to be monitored and corrective action taken if necessary, can be used as part of a business plan to help raise finance and identifies in advance times of negative closing balances allowing the business to plan for these
Give 2 disadvantages of cash flow forecasts
Any 2 from based on forecasts and therefore may be inaccurate, cannot plan for unexpected events such as a rise in the cost of raw materials and time taken to produce a cash flow forecast could have been spent on other tasks
Break-even is the point at which a business…
is not making a profit or a loss, i.e. it is just breaking even
Break-even is the point at which a business is not making a profit or a loss, i.e. it is just breaking even. This means that money…
being received from sales is the same as the money being spent on costs
What are the four categories of costs to a business?
Variable costs, semi-variable costs, fixed costs and total costs
Variable costs
Vary with the level of output, for example raw materials
Semi-variable costs
Part of the cost stays the same and part varies in relation to the degree business activity, for example a worker may be paid a fixed rate of pay but at busy times earn additional payments for working overtime
A worker may be paid a fixed rate of pay but at busy times earn additional payments for working overtime. Which type of cost to a business is this an example of?
Semi-variable
Fixed costs
Do not vary with output, for example rent
Rent is an example of what type of cost?
Fixed costs
Total costs =
fixed costs + variable costs
Total revenue
The total amount of money coming coming in from sales, calculated as quantity sold multiplied by selling price
Total sales
The amount of sales made in a set time period, for example a year; this can be expressed as value or volume
True/False: Total sales can be displayed as value, but not volume
False, total sales can be displayed as value or volume
Selling price per unit
The amount a customer pays for each unit bought
Sales in value
Sales expressed in monetary value, for example pounds, calculated as quantity sold multiples by selling price per unit
Sales in volume
Sales expressed as a quantity, for example tons or units
Break-even is the point where total revenue =
total costs
How is break even calculated?
Fixed costs / contribution per unit
Fixed costs / contribution per unit is the equation for…
break-even point
How is contribution unit calculated?
Selling price - variable costs per unit
How is total contribution calculated?
Sales revenue - total variable costs
How is total variable cost calculated?
Variable cost per unit x quantity or contribution per unit x number of units sold
How is contribution per unit calculated?
Selling price - variable costs per unit
Sales revenue - total variable costs =
How is total contribution calculated?
Variable cost per unit x quantity or contribution per unit x number of units sold =
How is total variable cost calculated?
What is margin of safety?
The actual number of units sold over and above the break-even point
Margin of safety =
Actual sales in units - break-even level of output
Contribution per unit =
selling price - variable costs
Break-even point =
fixed costs / contribution per unit, contribution per unit = selling price - variable costs then margin of safety = actual sales - break-even level of output
Break-even can be shown on a break-even _____
chart
A break-even chart plots the _____ and ________ at each unit of output
costs and revenues
On a break-even chart, the break-even point is where the…
total cost line crosses the total revenue line
A break-even chart can also be used to calculate…
margin of safety and profit or loss at different levels of output
Break-even level of output is the level of output where the business is making…
neither a profit nor a loss
If a business sells less than the break-even level of output, then it is…
making a loss
For every item sold above the break-even level a business is…
making a profit
True/False: Profit and loss can be shown on a break-even chart
True
What is contribution per unit used by businesses to do?
Help inform decision making
Give 2 examples of benefits of contribution per unit as a decision-making tool
Any 2 from straightforward to calculate, allows for the calculation of break-even level of output, can be used to inform decision, e.g. what price to change and can be used to carry out what-if analysis
Give 2 examples of limitations of contribution per unit as a decision-making tool
Any 2 from does not take into account fixed costs, assumes that prices remain constant and does not take into account any unexpected changes to variables, e.g. selling price and variable costs can fluctuate
Give 3 things that break-even can be used as a management tool for
Any 3 from planning, monitoring, control and target setting
Give 2 examples of how break-even can be used as a management tool for planning
Any 2 from sets budgets for the amount of sales necessary and costs, forms part of a business plan to show at what point the business will start to make a profit and informs pricing decisions
Give 2 examples of how break-even can be used as a management tool for monitoring
Any 2 from monitor progress towards achieving break-even point, identify changes to selling price of costs and take corrective action if targets look unlikely to be met
Give 2 examples of how break-even can be used as a management tool for control
Any 2 from keeps costs within budget, motivate employees and manage sales account
Give 2 examples of how break-even can be used as a management tool for target setting
Any 2 from set sales targets for individual employees, teams or products, set expenditure budgets and set profit budgets based upon sales targets and cost targets
Give 4 advantages of break-even
Any 4 from the business knows how many items it must sell in order to break-even, informs decisions on what price to change, can set targets, identifies fixed and variable costs, can identify if costs are too high allowing the business to look for ways of lowering costs, can set targets which will motivate employees and easy way to calculate profit oarless at different levels of output
Give 2 disadvantages of break-even
Any 2 from does not take account of variation in costs or selling price, forecast sales may not be achieved and hence, even though the break-even point is known, it may not be achieved and targets set may be too high, creating stress
True/False: Break-even informs decisions on what price to charge
True
True/False: Break-even does not help in setting targets
False, it does
True/False: Break-even identifies fixed and variable costs
True
Break-even can identify if costs are too high allowing the business to…
look for ways of lowering costs
Break-even can set targets which will do what to employees?
Motivate them
Break-even is an easy way to calculate profit or loss at different levels of ______
output
True/False: Break-even takes into account variations in costs or selling price
False, it doesn’t
True/False: Knowing your break-even point guarantees you to break even
False, it does not
What are the implications of setting targets too high from a break-even chart?
Stress
