Section 2.1.32 Planning and Cash Flow Flashcards
planning and cash flow
planning a firm’s financial requirements is helped by a clear, detailed business plan. cash flow is the flow of money into and out of a business in a given time period
a good plan should be
persuasive to an outside investor and useful to the entrepreneur
a good plan should explain
what makes the business special and help the entrepreneur to focus on what she or he is trying to achieve.
a good plan will help
the outsider understand the risks and rewards involved in the proposal. the outsider could be a bank or ‘dragon’ type of investor interested in an ownership stake of the business
a banks main concern is
that the start-up will be a safe investment
a ‘dragon’ is mainly interested in
the upside potential - that is, the chance of making a huge profit
either type of financier will want
to see a carefully prepared plan with a well-considered proposal for the sums of money needed
the heart of a business plan should be based around
competitive advantage
competitive advantage
identifying the features of your own product or service that will make it succeed against competitors. this may be based on a unique idea, a better product or service or the protection provided by a patent or copyright. on the other hand, a business may decide to strip a product or service down, to make it possible to be the cheapest in the market
business plans usually contain:
1) executive summary
2) a product/service
3) the market
4) marketing plan
5) operational plan
6) financial plan
7) conclusion
executive summary
- should be short, but compelling enough to persuade the busy banker to want to read on
- should say who you are, what the customer’s ‘pain’ is and how you will ‘relieve’ it
- why your team is ideal for the task
- how much capital you need for the start-up
- how much you are putting in yourself
the product/service
- explain it from the customer’s point of view
- if others already offer the service, you must explain what is different about your idea
the market
- focus on market trends rather than market size, such as whether the market is growing and, if so, how rapidly
- provide a brief analysis of key competitors
marketing plan
- who are you targeting and how do you plan to communicate with them
- how expensive will this be
- there should be an explanation and justification for the prices you plan to set plus a forecast of likely sales per month for the first two years
operational plan
- how will the product or service be produced and delivered
- could include production in china, which you will need to have already made contacts with willing suppliers
financial plan
- the heart of this will be cash flow forecast
- this will give an idea of the bank balances over the start-up period, and therefore the financing needs
conclusion
includes some idea of the longer-term plans for the business, including any ‘exit strategy’ - for example, a plan to sell the business within five years
interpreting a cash flow forecast
- a cash flow forecast is carried out by estimating all the money coming into and out of the business, month by month
- these flows of money are then set onto a grid showing the cash movements in each month - and how those movements affect the overall cash holdings (closing balance)
cash inflow
sums expected to arrive each month, either from financial sources or from customers
cash outflow
planned payments per month, such as wages, paying suppliers and paying the landlord
cash flow forecast is completed by calculating:
1) monthly balance
2) opening and closing balance
monthly balance
- cash inflow for the month minus cash outflow
- shows each month if there is a positive or negative movement of cash
- when outflow is greater than inflow, the monthly balance will be negative
opening and closing balance
- like a bank statement
- shows what cash the business has at the beginning of the month (opening balance) and what the cash position is at the end of the month (closing balance)
closing balance
- closing balance is the opening balance plus the monthly balance
- the closing balance shows the overall state of the bank account at the end of the month
what does cash flow forecast show
- as there is no such thing as negative money, the cash flow forecast shows that action is needed to avoid problems in the early months
- easiest remedy would be to negotiate a bank overdraft
an unexpected payment is needed, such as a big fine for health and safety failings
- this increases the cash outflow
- which worsens the monthly balance
- which then worsens the closing balance for that month - and all the following opening and closing balances
three main ways to analyse a cash flow forecast:
1) calculate the difference between the closing balance at the end of the period and the opening balance at the start
2) use the monthly closing balance to assess the trends in the data
3) analyze the timings and the cash inflows and outflows
calculate the difference between the closing balance at the end of the period and the opening balance at the start
- gives a sense of what is happening over time
- if the overall cash balances are building up, then cash inflows are greater than cash outflows and the situation is comfortable
- if the balance is declining, urgent action may be necessary
analyse the timings of cash inflows and outflows
- although some firms sell goods for cash, most provide customers with interest-free credit
- the longer the customers take to pay, the longer the seller is without their cash
- any method of speeding up costumer payments can boost a firm’s cash flow
sum of money outstanding from customers is known as
receivables
firms not only have customers, they also have
suppliers
when buying goods on credit
the longer the credit period you can negotiate from suppliers, the longer your cash will be sitting in your bank account
as the money sits in your bank account, this money owed is known as
payables
if a company has customers who pay in 30 days and suppliers who are paid in 30 days, business call this
a ‘cash-to-cash’ figure of zero (which is fantastic)
if customers take 60 days to pay but suppliers have to be paid in cash, that is
a cash-to-cash figure of 60 - which would put a strain on any business’ cash flow position
if a business forecasts a period of negative cash flow, it can work to improve its positions in three ways:
1) getting goods to the market in the shortest possible time
2) getting paid as quickly as possible
3) keeping stick of raw materials to a minimum
getting goods to the market in the shortest possible time
- the sooner goods reach the customer, the sooner payment is received
- production and distribution should be as efficient as possible
getting paid as quickly as possible
- the ideal arrangement is to get paid cash on delivery
- most business, though, works on credit
- even worse, it is an interest-free credit, so the customer has little incentive to pay up quickly
- early payment should be encouraged by offering incentives, such as discounts for early payment
keeping sticks of raw materials to a minimum
good stock management such as just-in-time system means that the business is not paying for stocks before it needs them for production
cash flow can also be improved by
keeping cash in the business through minimizing short-term spending on new equipment
things that the business can do to inprove cash flow and keep cash in the business include (and what they do):
1) leasing rather than buying equipment: this increases expenses but conserves capital
2) renting rather than buying buildings: this also allows capital to remain in the business
3) postponing expenditure - for example, on new company cars
cash flow forecasts have their limitations, however:
- they are only as good as the raw data put in
- they risk giving the impression of certainty where none exists
- because of these things it is vital to allow for contingencies - that is, things that can wrong
they are only as good as the raw data put in
entrepreneurs have to be optimistic by nature, so they may overestimate sales and underestimate operational difficulties (and therefore cash outflows)
they risk giving the impression of certainty where none exists
especially at start-up, who knows how long business customers will take to pay
because of these things it is vital to allow for contingencies - that is, things that can go wrong
so a clever cash flow forecast includes a planned overstatement of costs, to allow for unexpected problems
best case:
an optimistic estimate of the best possible outcome - for example, if sales prove much higher than expected
business plan:
a document setting out a business idea and showing how it is to be financed, marketed and put into practice
cash flow forecast:
estimating future monthly cash inflows and outflows, to find out the net cash flow
just-in-time:
ordering stick so that it arrives just before it is needed, just in time, i.e. having no stockpiles to cover for late deliveries
overdraft:
short-term borrowing from a bank. the business only borrow as much as it needs to cover its daily cash shortfall
worst case:
a pessimistic estimate assuming the worst possible outcome - for example, sales are very disappointing
why is it important to ask who constructed the cash flow forecast
because unconscious bias may have slipped in, e.g. an entrepreneurs optimism may make the cash flow projections unrealistic
why may it be a concern if a company’s sales are dominated by one large customer
because any disagreements about the invoice may lead to payment delays - which may be crippling if the bulk of cash inflow is due from that one customer
why is cash flow often referred to as ‘the lifeblood’ of the business
partly because it’s that important to a business survival and partly because, like blood, you only think about it when something’s gone wrong
why is it important to distinguish between slow payment and slow sales as causes of cash flow problems
slow payment is a purely cash-related issue that could be sorted out between accounts departments; slow sales may be a far more long-term problem - and will involve the marketing department
why should a business analyse the causes of a cash problem before opting to increase its overdraft limits
because overdrafts are expensive and all they do is cover over the cash flow problems; they don’t solve them
how should a business make its estimates for future cash inflows and outflows
by being pessimistic with the cash inflows (keep them low) and also with the cash outflows (be pessimistic; suspect they will be quite high)
