Cash-flow

Aim: Explain how a cash flow works

Objectives:
• Why cash is important to a business
• What a cash-flow forecast is, how a simple one is
constructed and the importance of it
• Amend or complete a simple cash-flow forecast
• How to interpret a simple cash-flow forecast
• How a short-term cash-flow problem might
be overcome
• The concept and importance of working capital
 Why is cash important to a business
• Cash is the money available to a business that
can immediately be used.

• The business needs to have an adequate

amount of cash to be able to pay for all its
short-term payments or the business could go
into liquidation– selling everything it owns to
pay its debts.
 Why is cash important to a business
Cash is needed to
• Pay suppliers
• Pay wages
• Maintenance
• Bills…

•
 Cash flow
The cash flow of a businesses is its cash inflows and cash
outflows over a period of time. When a firm sells its
products, money flows in. When it buys materials or pays
wages, money flows out.

Sal
es s
a t e rial
m
Raw

Loan
Interest
payments

b t ors Van
De mai
nte
nan
ce
 Cash inflows
Cash inflows are the sums of money received by
the business over a period of time. E.g.:
• sales revenue from sale of products

• payment from debtors– debtors are

customers who have already purchased goods

from the business but didn’t pay for them at
that time
• money borrowed from external sources, like

loans the money from the sale of business

assets
 Cash outflows
Cash outflows are the sums of money paid out by the
business over a period of time. Eg:
• purchasing goods and materials for cash
• paying wages, salaries and other expenses in cash
• purchasing fixed assets
• repaying loans (cash is going out of the business)
• by paying creditors of the business- creditors are
suppliers who supplied items to the business but
were not paid at the time of supply.
CashFlow
Cycle
Cashflow is not the same as profit!
• Profit is the surplus amount after total costs
have been deducted from sales.
• It includes all income and payments incurred
in the year, whether already received or paid
or to not yet received or paid respectfully.
• In a cash flow, only those elements paid by
cash are considered.
 Can a profitable business run out of cash?
Profit calculations
Liam sells goods worth $40K to his customer who is allowed
to pay 50% in cash and the rest in 60 days. To calculate Profit
sales (50% cash & 50% credit)
= 20K +20K
= $40,000
Assuming
Cost of sales However… Liam’s Cash
= $15,000 then Liam’s
flow calculation:
Gross Profit Opening Balance...... $0
= 40k - 15k Cash inflow................ $20,000
= $25,000 Cash outflow............. $15,000
Closing balance....... $5,000
 Cash Flow Forecast
A cash flow forecast is an estimate of the future cash inflow and outflow
of a business, usually on a month by month basis. It is a good way of
predicting when the firm might face a liquidity problem.
 Cash Flow Forecasts
This then shows the expected cash balance at
the end of each month. It can help tell the
manager:
• how much cash is available for paying bills,

purchasing fixed assets or repaying loans

• how much cash the bank will need to lend to

the business to avoid insolvency (running out

of liquid cash)
• whether the business has too much cash that

can be put to a profitable use in the business

 Cash flow forecast
CASHFLOW FORECAST FOR THE XYZ COMPANY LTD.

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Cash Inflows:

Sales £100 £155 £200 £300 £315 £325 £350 £430 £450 £500 £490 £580

Debtors £50 £100 £0 £0 £0 £0 £0 £210 £40 £0 £0 £0

Loan £1,000 £0 £200 £0 £0 £0 £0 £0 £0 £0 £0 £0

Total cash inflows £1,150 £255 £400 £300 £315 £325 £350 £640 £490 £500 £490 £580

Cash Outflows:

Raw materials £150 £200 £310 £250 £230 £110 £150 £160 £190 £200 £210 £210

Van costs £170 £170 £100 £180 £190 £190 £200 £195 £200 £190 £190 £195

Loan Interest £40 £50 £60 £60 £70 £70 £70 £70 £70 £70 £70 £70

Total cash outflows £360 £420 £470 £490 £490 £370 £420 £425 £460 £460 £470 £475

Net cash flow £790 -£165 -£70 -£190 -£175 -£45 -£70 £215 £30 £40 £20 £105
Opening bank
balance £500 £1,290 £1,125 £1,055 £865 £690 £645 £575 £790 £820 £860 £880

closing bank balance £1,290 £1,125 £1,055 £865 £690 £645 £575 £790 £820 £860 £880 £985
Example of a cash flow forecast for the four months:
 Cash flow forecast
● The opening cash/bank balance is the amount of cash
held by the business at the start of the month

● Net Cash Flow = Total Cash Inflow – Total Cash Outflow

● Closing cash/bank balance– the amount of cash held by

the business at the end of the month. Remember, the
closing cash/bank balance for one month is the opening
cash/bank balance for the next month!
● Closing cash/bank balance = net cash flow + opening
cash balance

● The figures in bracket denote a negative balance, i.e., a net

cash outflow (outflows > inflows)
 key terms
opening balance - the money available at the beginning
of the month to start trading
closing balance - the money left at the end of the
month- this is moved to start the next month as
opening balance
net cash flow = total cash inflow - total cash outflow
closing balance = net cash flow + opening balance
 Uses of cash flow forecasts:
● When setting up the business the manager needs to know how much
cash is required to set up the business. The cash flow forecast helps
calculate the cash outflows such as rent, purchase of assets,
advertising etc.

● A statement of cash flow forecast is required by bank managers when

the business applies for a loan. The bank manager will need to know
how much to lend to the business for its operations, when the loan is
needed, for how long it is needed and when it can be repaid.

● Managing cash flow– if the cash flow forecast gives a negative cash
flow for a month(s), then the business will need to plan ahead and
apply for an overdraft so that the negative balance is avoided (as cash
come in and the inflow exceeds the outflow). If there is too much cash,
the business may decide to repay loans (so that interest payment in the
future will be low) or pay off creditors/suppliers (to maintain healthy
relationship with suppliers).
 Methods to increase cash inflow
Reduce credit terms to customers- say 2 months earlier
Increase cash sales with no increase in promotion-[sale of
inventories at lower than normal price]
Overdraft-flexible loans can be arranged
Short-term loan-fixed amount can be borrowed for an agreed period
of time usually 1 yr
Sale of assets- sell surplus assets to increase inflow
Sale and leaseback - sell surplus assets and immediately lease back
the assets. thus the asset does not leave the businesses premises
Debt factoring- sell debts to a factor business for immediate cash
 CAUSES OF CASH FLOW PROBLEMS
Lack of planning- A form of financial planning to predict potential cash flow
problems so managers can take appropriate action to overcome them
Poor credit control- means debtors may not be chased up for payment leading to
bad debts
Allowing customers too much credit- reduces short-term cash inflows resulting in
cash flow problems
Expanding too quickly- means the business has to pay for the expansion, wages
and materials b4 it receives cash from additional sales – overtrading
Unexpected events- unforeseen increases in cost, competitor lowering prices
unexpectedly, a dip in predicted sales income could lead to a –ve cash flow
 Method to reduce cash outflow
● Increase bank loans: bank loans will inject more cash into
the business, but the firm will have to pay regular interest
payments on the loans and it will eventually have to be
repaid, causing future cash outflows
● Delay payment to suppliers: asking for more time to pay
suppliers will help decrease cash outflows in the short-run.
However, suppliers could refuse to supply on credit and
may reduce discounts for late payment
 Method to reduce cash outflow
● Ask debtors to pay more quickly: if debtors are asked to
pay all the debts they have to the firm quicker, the firm’s
cash inflows would increase in the short-run. These debtors
will include credit customers, who can be asked to make
cash sales as opposed to credit sales for purchases (cash
will have to be paid on the spot, credit will mean they can
pay in the future, thus becoming debtors). However,
customers may move to other businesses that still offers
them time to pay
 Method to reduce cash outflow
● Delay or cancel purchases of capital equipment: this will
greatly help reduce cash outflows in the short-run, but at
the cost of the efficiency the firm loses out on not buying
new technology and still using old equipment.
● In the long-term, to improve cash flow, the business will
need to attract more investors, cut costs by increasing
efficiency, develop more products to attract customers and
increase inflows.
 Method to reduce cash outflow
● Delay payments to suppliers/creditors
● Delay spending on capital equipment
● Use leasing not outright purchase of
capital equipment
● Cut overhead spending that does not
directly affect output eg:promotional cost
 Key terms...
Working capital
The amount of money available to
a business to meet its day-to-day
expenses and short-term debts.

Liquidity
Is the ability for a business
to pay its short term debts.

Insolvency
Describes a situation when a
business is unable to pay its debts.
 Insolvency
There is a clear difference between profit & cash.

Although the goods have been sold, the business has

only received payment for 50% of them. Customers
buying goods on credit will pay cash for them in later
months.

Therefore, YES a profitable business can run out of cash.

This situation is called insolvency. (liquidity crises)

Insolvency occurs by:

•Allowing customers too long a credit period or
•buying too many fixed assets, and thus having very little working capital
What have we learnt?

Discuss with a
partner before you
share it with the
class
 Example 1
Amend Cash-flow forecast

Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08

Cash Inflow:

Sales £350 X £325 £300 £275 £250

Loan £0 £0 £0 £0 £0 Y

Total cash inflows £350 £350 £325 Z £275 £1,250

Cash inflow shows all the money that flows into the business from the
sale of products or loans
 Example 2
Cash-flow forecast
Cash outflows: Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08

Raw materials £150 £200 £310 £350 £400 W

Van costs £170 £200 £250 X £270 £280

Interest £40 Y £50 £100 £150 £140

Total payments Z £400 £610 £710 £820 £920

Total payments is made up of the costs the business is expecting

to pay out. In July 2008, the business expects to pay out £360
The business expects costs to rise in the next 6 months! Van costs
have risen considerably, why?
 Example 3
Cash-flow forecast
Cash Inflows Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08

Sales £350 £350 £325 £300 £275 £250

Loan £0 £0 £0 £0 £0 £1,000

Total cash inflows £350 £350 £325 £300 £275 £1,250

Cash outflows:

Raw materials £150 £200 £310 £350 £400 £500

Van costs £170 £200 £250 £260 £270 £280

Interest £40 £0 £50 £100 £150 £140

Total cash outflows £360 £400 £610 £710 £820 £920

Net cash flow -£10 -£50 -£285 -£410 -£545 £330

Opening bank balance £105 £95 £45 -£240 -£650 -£1,195

closing bank balance £95 £45 -£240 -£650 -£1,195 -£865

Closing balance are the most important figures, if the figure goes too low,
the business has a cash flow (liquidity) problem.
 What have we learnt?
• What a cash flow is.
• How to work out total receipts & total
expenditure.
• Why cash flow forecast is important.
• How to input a cash flow on to a
spreadsheet.
• And........................................................
Now to Past papers
calculate X and Y
Calculate X and Y
Calculate X and Y
CalculateW, X, Y and Z
Calculate W,X,Y and Z
Calculate ?
calculate X and Y