Chapter 30

FORECASTING and MANAGING

CASH FLOWS
30.1Cash flow forecasts:
meaning and purpose
 Cash flow forecasts
Important in long run
More important in short run
become insolvent go into liquidation
Business cannot meet its short-term debts
uses cash flow forecasts particularly important for start-ups

shorter credit periods

need to see evidence of cash flow forecast
limited finance

Estimate of firm’s future cash inflows and outflows

Payments in cash received by a business

Payments in cash made by a business

 a) Interpretation of cash flow forecasts

• Owner’s own capital injection • Lease payment for premises

owner’s direct control in estate agent’s details of the property
• Bank loan payments if • Annual rent payment fixed
and agreed for a certain period of time
agreed with bank in advance
• Electricity, gas, water and telephone bills
• Customer’s cash purchases vary with many factors
Depend on sales
may not be very accurate
• Wage payments
• Trade receivables payments demand fluctuates staff are on flexible
(i) likely sales level contracts
on credit (ii) timing of cash payment by • Cost of materials and payments to suppliers
trade receivables vary with the level of output credit period
offered by suppliers

Sale of debentures Issue of shares Capex Payment of loan Payment of

dividend
b) Structure All figures in $000 January February March April
CASH INFLOWS
of cash flow Owner’s capital injection 6 0 0 0
forecasts Cash sales 3 4 6 6
Payments by trade receivables 0 2 2 3
Total cash in 9 6 8 9
CASH OUTFLOWS
Lease 8 0 0 0
Rent 1 1 1 1
Cash held
at the start of the Payment to trade payables 0.5 1 3 2
month Labour 1 2 3 3
Other costs 0.5 1 0.5 1.5
Cash held at the
end of the month Total cash out 11 5 7.5 7.5
NET CASH FLOW (2) 1 0.5 1.5
next month’s Opening balance 0 (2) (1) (0.5)
opening balance Closing balance (2) (1) (0.5) 1
indicates need for a bank overdraft
c) Amendments of simple cash flow forecasts:
Calculating opening and closing balances
All figures in $000 April
CASH INFLOWS
Owner’s capital injection 0
Cash sales 6=1=7
Payments by trade receivables 3
Total cash in 10
CASH OUTFLOWS
Lease 0
Rent 1
Payment to trade payables 2 + 0.5 = 2.5
Labour 3
Other costs 1.5 + 1 = 2.5
Total cash out 9
NET CASH FLOW 1
Opening balance (0.5)
Closing balance 0.5
 d) Cash flow forecasting

• Show negative closing cash flows • Mistakes in preparing revenue and cost
plans to source additional forecasts if prepared by
finance inexperienced staff
• Unexpected cost increases
• Indicates periods of time when negative forecasts inaccurate
net cash flows are excessive
take corrective action • Wrong assumptions in estimating sales
of the business makes CF forecasts
inaccurate
• Essential part of the business plan
investors and bankers need cash flow
forecasts and the assumptions behind it
 e) Causes of cash flow problems
No CF forecasts did not predict potential cash flow problems

monitoring of debts to ensure that credit periods are not exceeded

keeps a check on all customers’ accounts
Delay in payments Bad debts are not identified = unpaid customers’ bills that are
unlikely to ever be paid
customers prefer firm that is allowing credit
reduce short-
term cash inflows cash flow problems
needs higher payment for increased wages and materials months
before it receives cash from additional sales expanding rapidly without
obtaining all necessary finance cash flow shortage

unforeseen increases in costs

lead to negative net cash flows
 f) Methods of improving cash flow
Improve CFs and not sales revenue or profits
Rise in sales Fall in short-run cash flows

• Overdraft Flexible loan • Manage trade payables

High interest rates Overdraft
arrangement fee Bank can withdraw at short notice • Delay capital expenditure
leading to liquidity problems
Lower efficiency if
• Short-term loans Borrow fixed amount for less inefficient equipment is not replaced Expansion
than a year Pay interest Repaid within one becomes difficult
year • Use leasing
• Sale of assets cash sales of redundant asset Do not get ownership of the asset
Leasing charges include interest cost and increase
Lower price of asset when sold quickly asset overheads
may be required later Asset could have been used as
collateral for future loans • Cut overheads that do not directly affect
• Sale and leaseback Pay lease rentals Loss if output, e.g. reduce promotion Lower sales
asset price rises Asset could have been used as
collateral for future loans
• Manage trade receivables
• Sale of shares and Issue debentures
 Improving cash flows by managing trade
receivables
• Not extending credit to customers / reducing credit period (i.e. asking customers
to pay more quickly
Lower risk of bad debt Lower cash stuck in working capital
Customers may switch to competitors
loses an important marketing tool
• Selling claims on trade receivables to specialist financial institutions = debt
factors
improves liquidity
Does not get the full amount
• Carefully investigate creditworthiness of new customers Require references
credit enquiry agency
Reduces risk of bad debts
expensive and time consuming
• Offering prompt-payment discounts (discounts for early payments)
improves liquidity
reduce the profit margins on sales
 Improving cash flows by managing trade
payables
• Purchasing more supplies on credit and not cash
Cheap source of finance
Some suppliers may not give credit terms Lose prompt-payment
discount
• Extend period of time taken to pay

Cheap source of finance

Suppliers may be
reluctant to supply reluctant to offer good service
Evaluation
Activity 30.2
End of chapter