Using Cash Flow Forecasting

Lesson Objectives

• The nature of cash flow• How to forecast cash flow• The structure of a cash flow forecast• Why businesses forecast cash flow• Try a past paper question

The nature of cash flow

Cash flows into AND out of a business

Cash salesPayments from debtorsOwners’ capital investedSale of assetsBank Loan

Purchasing stockPaying wagesPaying debts – bank loans, creditorsPurchasing assets of assets

Cash flow is interested in the balance between these cash inflows and cash outflows in terms if their relative size and timings.

The nature of cash flow

• Cash flow is important to a business as it needs to ensure a positive cash balance in order to be able to meet day to day expenses

• A potentially profitable business may fail because it has cash flow problems

Factors affecting the nature of cash flow

• Transaction types– Sales – Cash v. Credit– Purchases – Cash v. Credit– Payment terms

• Timings of cash flows– Seasonal Sales

• Strawberry farm– Timings of payments in and out

• Package holiday company• Nature of business

– Start-up capital and costs– Time taken from input to output– Stock holdings

The nature of cash flow

• A cash flow forecast is a forward looking statement that tries to predict cash inflows and outflows in the future

• Cash flow forecasts are an important part of a business plan

• A cash flow statement is a backward looking statement that shows what happened to cash inflows and outflows

• Cash flow statements are normally presented as a part of a business’ accounts

How to forecast cash flow – a prediction of the monthly inflows and outflows

• Cash inflows– Owner’s Investment or other source of finance

• probably month one only – figure should be known– Cash Sales estimated from sales forecast

• may be over or under estimated • to some extent depends upon the scale of research• More difficult for new businesses

– What is expertise of entrepreneur?– How have estimates been calculated?– Is it a new product or service?– How might competitors react?

– Debtor payments estimated from sales forecast• Determined by credit terms offered to customers

– Will debts be paid on time?– How good is firm’s credit control?

How to forecast cash flow – a prediction of the monthly inflows and outflows

• Cash outflows– Payment of fixed costs

• These should be easy to estimate on a month by month basis• Time delay between estimates and signing contract etc can cause

inaccuracies– Payment of variable costs

• If sales are difficult to forecast logically so must the costs associated with meeting them

• Made more difficult if suppliers are free to change the prices charged– Unforeseen expenses

• Or just forgotten expenses! A new entrepreneur may find it difficult to even perceive all the costs never mind estimate how much they will be

– Payment terms• What if a supplier changes terms and wants payment sooner or a

lender demands their money back

The structure of a cash flow forecast• Cash Inflows shows:

– cash in from sales • cash sales appear in the month of sale• credit sales (debtor payments) appear in month of cash receipt

– cash from other sources e.g. loan, investment• Cash Outflows shows:

– cash out for purchases and payments• Cash payments appear in month of purchase• Credit payments appear in month of cash outflow

– E.g. Phone usage – line rental paid each month, call charges every 3 months

• Net cash flow– The net result of cash inflows and cash outflows each month– Net cash flow = cash inflows – cash outflows

• Opening balance– How much the business has at the start of each month– For a new business in month 1 this will be 0– The closing balance for one month becomes the opening balance for the next

• Closing balance– How much the business has at the end of each month– Calculated as:

• Opening balance + net cash flow

The structure of a cash flow forecastcash flow forecast for first 4 months of Tap It Plumbers

Jan Feb Mar Apr

Cash Inflows

Owner’s Capital 5000 0 0 0

Cash Sales1600 2000 2500 2500

Payments by debtors 0 400 500 500Total Inflows 6600 2400 3000 3000Cash Outflows

Van Lease 700 700 700 700Materials 2800 800 1000 800Wages 1000 1000 1000 1000Other expenses 450 450 450 450Total Outflows 4950 2950 3150 2950Net cash Flow 1650 (550) (150) 50Opening balance 0 1650 1100 950Closing balance 1650 1100 950 1000

Why businesses forecast cash flow

• To identify the timing and significance of any potential shortfalls

• To identify possible corrective action• To help secure finance from potential

investors or the bank• To give confidence about short term survival• To provide a guide against which to measure

actual cash flow

LET’S TRY A PAST PAPER QUESTION AND SEE HOW THAT GOES...

Task: look at this information taken from a past paper, it doesn’t show profit, to does show a problem at the end of one year can you spot it? What else can you see from the data? Can you extrapolate forwards to help you decide which option would be better – assume that inflows and outflows remain constant?

Task: look at this information taken from a past paper, it doesn’t show profit, to does show a problem at the end of one year can you spot it? What else can you see from the data? Can you extrapolate forwards to help you decide which option would be better – assume that inflows and outflows remain constant?

Here’s how the question looked on the paper – notice that it doesn’t wave A flag and say hey hey I’m a cash flow forecasting question, no you have

To work that out as well! Welcome to A Level :0)

Overdraft = cash flow question (most likley)

Here’s how the question looked on the paper – notice that it doesn’t wave A flag and say hey hey I’m a cash flow forecasting question, no you have

To work that out as well! Welcome to A Level :0)

Overdraft = cash flow question (most likley)

Total of 10 marks for this question – no evaluation required so don’t do one!Total of 10 marks for this question – no evaluation required so don’t do one!

This is taken from the examiners mark scheme – what they use to mark your answers: Always include a definition at the start of all your answers, its just polite, like shaking someone's hand when you meet them formally, see picture below for guidance :0)

This is taken from the examiners mark scheme – what they use to mark your answers: Always include a definition at the start of all your answers, its just polite, like shaking someone's hand when you meet them formally, see picture below for guidance :0)

Here’s the answer in all its glory, worth making a mindmap of the keypointsHere’s the answer in all its glory, worth making a mindmap of the keypoints

Here is an example of the kind of great mindmap that you could make. Here is an example of the kind of great mindmap that you could make.