iGCSE Business Studies

Section 5

Chapter 23 - Cash Flow Forecasting and Working Capital

Learning Objectives
i. To understand the importance of cash and cash-flow forecasting

ii. To explain the concept and importance of Working Capital

1) Why cash is important to a business

a. Using the A-Z keywords handbook, define the term “Current Asset.”

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 b. A business will typically have three types of Current Assets. Study and complete the table, below.

Example : Oishi Drinks Manufacturer

Definition
CURRENT
ASSETS

1. CASH $200,000 of cash in the business’ bank

account

2. STOCK $150,000 of stock in their warehouse

(i.e. Inventories) This will soon be sold (and eventually

converted into cash, possibly within the
month)

3. DEBTORS $350,000 worth of sales already delivered

to business customers, i.e. Tesco, Macro,
Big C, Tops Supermarket, etc.

Oishi expects to be paid within 28 days.

(Trade Credit)

c. Which of the above three CURRENT ASSETS is available now / today to pay for Oishi’s day-to-day
expenses? (Cash, Stock, or Debtors?)

……………………………………………………………………………………………………………………………………………………………………………………

d. Explain why “CASH,” unlike STOCK and DEBTORS, is immediately available to pay for the businesses
daily expenses. Why are the other two current assets a problem for the business and its cash flow?
(Read the example to help you, re. Oishi)

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e. Using the A-Z keywords handbook. Explain what the term “Cash-flow problems / “Poor cash flow”
means.

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f. What impact would “Poor Cash Flow” have on the Oishi Drinks manufacturer?

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2) What is meant by “Cash flow?”
Cash flow refers to the “flow of money In and Out of the business.”

Complete the table below – list the different inflows and outflows of cash for a business.
You can use pages 281-281 of the text book to help you.

Cash Inflows + (Money IN  ) Cash Outflows - (Money Out )

With your newly learnt knowledge, complete Activity 23.1, below.

a. Cash Flow Cycle

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 Refer to the “Cash flow cycle” diagram, above.

i. Carefully study the diagram. Look first at “Stage 1” and see how it progresses to “Stage 5.”

ii. Identify the one stage in the cycle when the business will receive payment for the goods it produces.
Put a large “tick” sign by the side of the box.

iii. Now, identity the remaining stages when no cash / payment is coming into the business.
Put an “X” by the side of each of those four boxes.

iv. Question: What type of business would the above Cash Flow Cycle refer to? A business in the:
a) Primary Sector, or
b) Secondary (Manufacturing) Sector, or
c) Tertiary Sector

(Clue: look at Stage 2&3 to help you)

Answer: _______________________

Reason: …………………………………………………………………………………………………………………………………………….

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v. Refer to the “Cash Flow Cycle” diagram on the next page. Use a Highlighter Pen to highlight the
following:
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 a. Cash INFLOW (from the sale of goods, known as “Sales Revenue”)

b. Cash OUTFLOW ( payment of expenses, known as “Expenditure”)

c. Cash In Hand (known as WORKING CAPITAL). This is the available cash held by the business to
pay for it’s expenses.

Now label correctly on the diagram the following words:

 Sales Revenue
 Expenditure
 Working Capital

vi. Why do businesses need “Working Capital?” What is it used for?

 …………………………………………………………………………………………………………………………………………………………….

 ……………………………………………………………………………………………………………………………………………………………..

 ……………………………………………………………………………………………………………………………………………………………..

vii. Would a long delay of 5-8 weeks before cash flows into the business have a positive or negative
impact on the business’s Working Capital? (i.e. the amount of available cash needed to pay for day-
to-day expenses) Explain why….

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viii. Businesses that do not have enough Working Capital (i.e. run out of cash) are known as having:

 “Cash Flow Problems” and will have problems paying expenses such as staff, stock, rent, bank
loans, water/electricity bills, etc….

 “Poor levels of Working Capital” / “POOR LIQUIDITY”

Solutions: A business will be forced to use “SHORT TERM FINANCE” to help it improve its Cash
Flow (LIQUIDITY)

Complete the table below to help show which sources of SHORT TERM FINANCE a business could
IMMEDIATELY use to improve its cash flow temporarily. (Refer to the previous chapter, Sources of
Finance, to help you)
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 SHORT TERM FINANCE (repayable within one year)
Internal Source of Finance External Source of Finance
1. Retained Profit could be used because… 1. Bank Overdraft could be used because…..

2. The Owners Savings could be used because… __________________________

ix. Refer to the “Cash Flow Diagram” on Page 4 again. What impact might the following have if the
business did not have enough cash at Stage 1?

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x. Refer to Stage 4 and Stage 5. Why will there be a delay in payment, typically of 28 days, before the
manufacturer is paid by its business customers?

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xi. What business term is used for this agreed 28 day delay in payment, between the manufacturer
(supplier) and the business customer?

“T_____________ C_____________”

xii. Which stages of the cycle could be removed if the business operated only in the Tertiary Sector
(Services Sector), and was not involved in manufacturing? Explain why….

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b. Understanding “Cash Flow”

Cash flow is NOT the same as Profit! As Business Studies students, you cannot confuse these terms.

To help improve your understanding, complete the table below. The missing words are:

 Profit
 Cash Flow

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 Now, highlight the essential terms in each of the two statements, below

Key word Definition

This is the flow of cash in and out of the business over

a period of time (i.e. one month)

This is the surplus / the money left over after all your costs (expenses) have
been deducted, i.e. Sales Revenue (money in) – Expenses

c. Understanding “Profit”
NOTE: This section of the Finance chapter is Essential!

You must take great care to understand this before progressing onwards

To truly understand how “Profit” is calculated,

 read the table below and the example to help you, based on Subway Sandwiches
 complete the ”definition” column

Definition Example, based on

Sales Revenue
(Money In) $200,000 of SALES made in one month
from the sale of food at the store

Cost of Goods $50,000 spent by Subway for the stock

Sold (Money (Bread, cheese, meat, drinks, mayo ,
Out) food packaging)

I.e: “COST OF GOODS SOLD “

(Also known as “Direct Costs”)
GROSS PROFIT

$150,000 of Gross Profit, after the

“Cost of Goods” have been deducted

Overheads $80,000 of other additional expenses

(Money Out) from the operating the store (known as
OVERHEADS / INDIRECT COSTS).

For example:
Staff Costs
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 Electricity Bills
Rent
Water Bills
Petrol Fuel costs
NET PROFIT
$70,000 of Profit that month,
after ALL EXPENSES have been deducted

Now, using your knowledge, complete the short case study, below.

 Answer One.

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 Answer Two.

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 a)

………………………………………………………………………………………………………………………………………………………………………………….

b)

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c)

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3) Understanding “Cash Flow Forecasting”

a. Why use “Cash flow forecasts?”

Study the case study below. You must understand it before continuing on to the next stage.

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 4. Setting up a business
Setting up a business is a very expensive first stage in the life of a business. List three expensive things an
entrepreneur would have to purchase when setting up a business, ie. Sandwich Store or Coffee Shop:

 ………………………………………………………………………………………………………………………………………………………………

 ………………………………………………………………………………………………………………………………………………………………

 ………………………………………………………………………………………………………………………………………………………………

 Why does the “setting up stage” put get pressure on a business’s “Cash-Flow?”
(Think about money flowing both in and out of the business)

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 Define the term: “Cash Flow Forecast”

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 Explain how a Cash Flow Forecast can help new businesses avoid running out of cash (Working Capital)

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5. Speaking with your Bank Manager

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 Banks are often used by businesses to access additional cash.

Give two reasons to explain why a bank will never lend cash to a business (new or existing) unless the owner
has shown them a Cash Flow Forecast.

 ………………………………………………………………………………………………………………………………………………………………………
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 ………………………………………………………………………………………………………………………………………………………………………
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6. Managing an existing business

Explain why all businesses, not just new ones, must have a cash flow forecast in place for the coming year.
How will cash flow forecasting help them manage their finances?

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 …………………………………………………………………………………………………………………………………………………………………
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7. Managing your Cash Flow

As a business grows, its cash flow should begin to improve. In time, successful businesses will have too much
cash held in their business’s bank account.

What two things could a business do if it has surplus/high levels of cash?

 …………………………………………………………………………………………………………………………………………………………………
 …………………………………………………………………………………………………………………………………………………………………

Complete Activity 23.3, below to help you strengthen your cash flow forecasting skills

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 a) …………………………………………………………………………………………………………………………………………………………

b) …………………………………………………………………………………………………………………………………………………………
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c) …………………………………………………………………………………………………………………………………………………………
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Read the Case Study example below, re. Capri Motors Ltd.

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Use the information provided above to complete the template Cash Flow Forecast.

January February March April

Cash Inflows
Cash sales
Total Cash Inflow

Cash Outflows
Materials
Other cash expenses
(Wages, Rent, Insurance, Etc
Total Cash Outflow

Opening Bank Balance

Net Cash Flow
Closing bank balance

a) Explain to the manager the importance of cash flow forecasting. (State two benefits)

 ………………………………………………………………………………………………………………………………………………………..

 .……………………………………………………………………………………………………………………………………………………….

b) What do you notice about the closing bank balance in April?

……………………………………………………………………………………………………………………………………………………………………..

c) What action could the manager of Capri Motors Ltd take, now that she is aware of this future
problem?

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……………………………………………………………………………………………………………………………………………………………………..
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8. How can “Cash flow problems” be overcome / managed?

a. Short Term solutions

Read and take care to understand the table, below.

b. Long Term Solutions to Cash Flow Problems.

Complete the table, below. Use the bottom of page 287 of the text book to assist you.

Benefits of this solution The problems that may arise

1. Attract new
investors New investors may want to have control /
influence over the running of your
business

2. Cut costs &

increase
efficiency

3. Develop
New
Products

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 a. What are the cash flow problems facing this business?

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b. What “Short Term” and “Long Term” Recommendations would you give to Manuel?

Short Term Recommendations:

i. ………………………………………………………………………………………………………………………………………………………

ii………………………………………………………………………………………………………………………………………………………….

Long Term Recommendations

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 9. ESSENTIAL CASE STUDY - The importance of “Working Capital”

Part A.

i) …………………………………………………………………………………………………………………………………………………………
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ii) …………………………………………………………………………………………………………………………………………………………
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Part B.

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 Cash Flow Forecasting and Working Capital
Essential keywords
Key word Definition
1.
The cash inflows and outflows over a period of time of a business.

2. The sums of money received by a business during a period of time, ie. from:
 the sale of products for cash
 payments made by debtors
 borrowing money from an external source (i.e. Bank loan)
 the sale of assets of the business (unwanted property)
 investors putting money into the business

3. The sums of money paid out by a business during a period of time, i.e.
 purchasing goods or materials for cash
 paying wages, salaries and other expenses in cash
 purchasing fixed assets
 repaying loans
 paying creditors (i.e. suppliers)

4.
It shows the stages between:

a) paying cash for labour, materials, etc. (Cash flowing out)

b) receiving cash from the sale of goods. (Cash flowing in)

5.
The surplus (what is left over), after Total Costs has been deducted from Sales
Revenue. It can be increased by:
1. Increasing sales revenue by more than costs
2. Reducing cost of making product

6. An estimate of future cash inflows and outflows of a business, usually on a

month-by-month basis.

This then shows the expected cash balance at the end of each month.

7.
The amount of cash held by the business at the start of the month.

8. The difference each month, between inflows and outflows.

= (Cash inflow) – (Cash outflow)

9. The amount of cash held by the business at the end of each month.

This becomes next month’s opening cash balance.

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10.
The capital available to a business in the short term to pay for
day-to-day expenses.

= (Current assets) – (Current liabilities)

The success of a business depends upon who well it can manage this

So, it should be handled carefully because it shows the efficiency and financial
strength of company.

Profit Cash Flow

Opening cash (bank) balance Cash flow cycle

Cash inflows Working capital

Closing cash (bank) balance Cash outflows

Cash flow forecast Net cash flow

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