BUSINESS AND MANAGEMENT

ACCOUNTING AND FINANCE

Cash Flow Forecasts

Cash Flow Forecasting

Why do businesses prepare cash flow forecasts

Cash flow forecasts are drawn up to help control and monitor cash flow in the business. The

following are some advantages of using statements to control cash flows.

1. Identifying the timing of cash shortages and surpluses.

2. Supporting applications for funding.

3. Enhancing the planning process.

4. Monitoring cash flow.

Cash Flow Forecast: This relates to the expected inflow and outflow of cash.

Cash Flow Statement: This relates to the actual flow (in and out) of cash during the past time period.

Cash Flow Forecast

CASH

Used to acquire resources

Resources used to make goods and

services

Goods and services sold for cash

The continuous Cash Flow into and out of the business

Why Cash flow is important to business

Without sufficient cash flow businesses would not be able to pay its many creditors on time. The possible implications are: creditors may stop supplying goods or impose strict conditions such as ‘cash on delivery’; discounts will be lost for prompt payments of bills; other traders will be less prepared to deal with the firm except on a cash basis.

Wages and salary may not be paid on time and this will cause poor motivation; absenteeism; high labour turnover; and industrial unrest.

New capital assets cannot be afforded and this can reduce business efficiency.

Tax bills may not be paid

Cost of holding too much cash

• Loss of interest: Although there may be a token amount of interest earned on current accounts, it will be nowhere near the interest rate for long-term accounts.

• Loss of purchasing power: Unless the rate of interest is more than the rate of inflation, the money held in a bank account will actually lose its purchasing power.

• Opportunity Cost: Investors do not invest money in a business for the business to store it in a bank account. Investors expect a business to take well managed risks with their money; in the money is in a bank account, the business is possible risk –averse and the investors may remove their investment.

Question: What are the costs associated with a business holding too little cash?

Causes of cash flow problems

Overtrading

Holding too much stock

High borrowing – therefore high interest payments.

Allowing too many goods to be bought on credit.

Businesses that rely on seasonal trade – during the time that sales are very low, cash still needs to be spent on running the businesses.

High unemployment.

The Relationship between profit and cash

Note: A profitable business may run out of cash, whilst the business recording a loss may have a cash surplus. How is this possible?

• The business may be selling more of its output on credit. Therefore a profit is being made as the goods are being recorded and sold, but the cash payment form customers will be received sometime in the future. This period of credit may leave the firm dangerously short of cash.

• The business may receive cash at the beginning of the trading year from sales made in the previous year. This would increase the cash balance but not affect profit.

• A business may buy resources from its suppliers and not pay for them until the next trading year. As a result the trading cost will not be the same as the cash paid out.

• When additional capital is introduced into the business this will increase the cash balance, but have no effect on profit. This is because capital is not treated as revenue in the Profit and Loss Account.

• The purchase of fixed assets will reduce cash balance but have no effect on the profit a company makes. This is because the purchase of an asset is not treated as an expense in the Profit and Loss Account.

• Sale of fixed assets will increase cash balances but have no effect on profit unless a profit or loss is made on the disposal of the asset. This is because profit from the sale of an asset is not included in the business turnover.

Activity: Question # 4, Unit 46, page 327 Hall Jones and Raffo, Business Studies, 3rd Edition.

The receipts of the business represents the monthly income of cash.

Payments are the outflows from the business. Some payments are often for the same regular amounts.

Net Cash Flow for each month is found by subtracting total payments from total receipts.

The opening balance in January will be the value of December’s closing balance in the previous year.

The closing balance for one month is found by adding or subtracting the net cash flow for the month for the

opening balance.

Cash Flow Forecasting

July August September October November

Receipts

Capital injection 10,000

Sales revenue 2,000 4,000 8,000 12,000 16,000

Total cash in 12,000 4,000 8,000 12,000 16,000

Payments

Capital Expenditure 15,000 2,000 2,000 2,000 4,000

Labour 2,000 3,000 4,000 6,000 6,000

Materials 3,000 4,000 4,000 4,000 4,000

Total Payments 2,000 9,000 10,000 12,000 14,000

Net Cash Flow ( 8,000) (5,000) (20,000) 0 X

Opening Balance 0 (8,000) (13,000) (15,000) (15,000)

Closing Balance (8,000) (13,000) (15,000) (15,000) Y

1. Calculate the missing values X and Y.

2. State two ways in which the business might be able to improve its forecasted cash flow.

3. Complete the table for December based on the following forecasts

Sales revenue raises by 10% from November.

Capital expenditure is double the November level.

Labour and material costs increase by 25%

The following cash-flow forecast is for ‘Plants4U’ flower shop which is about to begin trading (all figures in $000s)

Example of Cash Flow Statement

Managing Cash Flow

Managing the floe of cash in and out of the business is one of the most important tasks of management. In order to do this effectively managers will need to assess:

• The likely timing of cash flow in d out of the business. This will largely depend on how long debtors take to pay their bills.

• The size and likely timing of payments out of the business; this will largely depend on the costs of the business and period of credit offered by the suppliers.

• Whether there are sources of finance to cover periods when cash shortage could rise.

Time is of great significance to cash flow management

Dealing with Cash-Flow Problems

Reduce or delay expenditure

Obtain cheaper supplies

Rent or lease equipment rather than buying it outright

Delay the payment of bills – extending the credit period

Get cash in more quickly from the sale of goods

Use debt factor to release cash from debts

Obtain overdrafts or short term loans

Question: What are the advantages and disadvantages associated with these methods of dealing with cash flow problems?

Handout: Methods of improving Cash Flow, Advantages and Drawbacks

Case Studies

Westview Caravans

Source: Unit 46, page 329, Jones, Hall, Raffo, Business Studies 3rd Edition

Tourist Trinkets Limited

Source: Unit 5, pages 461-467, Stimpson,AS and A Level Business Studies

Setting up in Business

Source: Unit 5, pages 461, Stimpson,AS and A Level Business Studies

Windrush Training Services

Source: Unit 54, page 380, Jones, Hall, Raffo, Business Studies 3rd Edition

BIBLIOGRAPHY

1.Barratt Michael and Mottershead Andy. AS and A Level Business Studies, Pearson Education Ltd,2000.

2.Jewell Bruce. An Integrated Approach to Business Studies, 4th Edition, Pearson Education Ltd 2000.

3. Hall Dave, Jones Rob, Raffo Carlo. Business Studies, 3rd Edition, Causeway Press Ltd, 2004.

4. Stimpson Peter. AS and A Level Business Studies, Cambridge University Press, 2000.

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