3.

7 Cash flow

Section 3 Finance and accounts

Unit content

Content Assessment
objective
The difference between profit and cash flow AO2
The working capital cycle AO2
Cash flow forecasts AO2, AO4
The relationship between investment, profit and cash AO2
flow
Strategies to deal with cash flow problems AO3
Cash flow and the CUEGIS concepts
The number one cause
of business failure
• What is the number one
cause of business failure?
• Discuss this question
with your partner.
• Write your answer on a
sticky note and place it
on the wall indicated by
your teacher.
Cash flow
• Cash flow (or working capital) refers to
the cash or liquid assets available for the
daily running of a business.
• Day-to-day expenditures include items
such as paying for:
• Utilities
• Wages
• Raw materials.
• In order for firms to thrive, they need to
have more cash flowing into the business
than out of the business.
The difference between
profit and cash flow
Profit vs. cash Firm X and Firm Y have raised $10,000
capital to start up their new businesses
flow manufacturing windows.
Read the information in Firm X Firm Y
the table. • Got $5000 worth of • Got $5000 worth of
At the end of the month raw materials, paid raw materials. They
which company: upfront. got 30 days trade
• Manufactured 500 credit from the raw
1. Earned the most windows in 29 days. materials supplier.
profit? • On the 30th day, they • They manufactured
sold all 500 windows 400 windows in 29
2. Has the most cash for $20 per piece. days.
available? • On the 30th day, they
sold all 400 windows
for $16 per piece.
Cash flow ≠ profit Watch this video and answer the
following questions:
• For every financial transaction, 1. Can a firm be profitable yet
the activity is recorded on the have insufficient cash?
date the transaction occurred. 2. What will happen to the firm if
• This appears on the profit and it is profitable but does not
loss statement. have enough cash?
• However, the actual date the
cash payment is made for the
transaction can be a different
date.
• This appears on the cash flow
statement.
• This is due to trade credit
creating debtors and creditors.
The working capital
cycle
The working capital cycle
• The working capital cycle is the time difference between the firm
paying cash for its costs of production and receiving cash from sales
to customers.
Firm’s cash

Goods are sold to customers for Firm pays cash for raw
cash. It takes 50 days to sell all materials. It takes 10 days for
goods. Total the raw materials to arrive.
time lag:
90 days
Sale of Production
goods costs

Firm produces goods. Production time takes 30 days.

Liquidity
• Liquidity refers to how easily Relatively liquid
an asset can be turned into assets
cash. • Cash
• Debtors
• Relatively liquid assets are • Stock of
usually current assets finished
• i.e. they convert quickly into goods
cash.
• Relatively illiquid assets are Relatively
illiquid assts
usually fixed assets, but could • Fixed assets
include stocks of raw materials • Stock of raw
that have yet to be processed materials
into finished goods.
• i.e. they take a longer time to
turn into cash.
Liquidity crisis

• A liquidity crisis is when

there is insufficient cash in
the working capital cycle.
• This is due to more cash
flowing out of the business
than flowing into the
business.
Over to you
• In pairs, discuss the following:

•“The idea of having too much

cash in a business is just as
unfavorable as having not enough
cash.”

• Feedback your discussion

points to the class.
 Cash flow and the working capital cycle

• When there is too little cash, the Insufficient

cash
working capital cycle will be • Liquidity crisis
unable to continue and the • Threat of
business will become insolvent. insolvency
• i.e. The business will fail from being
unable to pay its debts.
• When there is too much cash, Excess cash
there is more than enough cash • Opportunity cost
for the working capital cycle to of not using cash
to grow the
continue. business
• i.e. Cash sits idle instead of being A firm must aim to have just the right
used to grow the business amount of cash to meet the needs of its
working capital cycle.
Over to you

• Hoang textbook
• Question 3.7.1
McDonald’s
• Page 312
• Question 3.7.2
Le Royal Méridien Hotels
• Page 314
• Answer all parts
Cash flow forecasts
Anticipating cash flow movements
Cash
• A cash flow forecast is a inflow
financial document that
shows the expected
movement of cash in and
out of a business over a
period of time.
• Cash flow forecasts contain
Cash
three key features:
Net cash flow outflow
• Cash inflows
• Cash outflows
• Net cash flow
Classify the following items as cash inflow or cash outflows
Item Cash inflow or cash outflow?
1. Sales revenue
2. Rental income
3. Dividends to shareholders
4. Payment to creditors
5. Wages
6. Debtors
7. Rent paid
8. Purchase of stocks
9. Interest received
10. Bank loans
11. Interest payments
12. Sale of assets
Classify the following items as cash inflow or cash outflows - ANSWERS

Item Cash inflow or cash outflow?

1. Sales revenue Cash inflow
2. Rental income Cash inflow
3. Dividends to shareholders Cash outflow
4. Payment to creditors Cash outflow
5. Wages Cash outflow
6. Debtors Cash inflow
7. Rent paid Cash outflow
8. Purchase of stocks Cash outflow
9. Interest received Cash inflow
10. Bank loans Cash inflow
11. Interest payments Cash outflow
12. Sale of assets Cash inflow
Cash flow forecast features
Item Definition
Opening balance The amount of cash at the beginning of a
trading period (same as the previous month’s
closing balance).

Cash inflows Any cash coming into the business.

Cash outflows Any cash leaving the business.
Net cash flow Cash inflows – cash outflows
Closing balance Opening balance + net cash flow
Worked example (page 316 Hoang textbook)
Sept ($) Oct ($) Nov ($) Dec ($)
Opening balance 1,000 800 1,600 1,900
Inflows
Cash sales 2,000 2,000 3,000 4,000
Total cash inflows 2,000 2,000 3,000 4,000
Outflows
Stock purchases 600 600 900 1,200
Rent 1,000 0 1,000 0
Other costs 600 600 800 1,000
Total cash outflows 2,200 1,200 2,700 2,200
Net cash flow (200) 800 300 1,800
Closing balance 800 1,600 1,900 3,700
 Complete this cash flow forecast
Sept ($) Oct ($) Nov ($) Dec ($)
Opening balance 1,300
Inflows
Cash sales 700 650 500 900
Credit sales 450 800 200 450
Total cash inflows
Outflows
Raw materials 400 200 375 600
Wages 500 500 500 500
Advertising 200 200 200 1100
Loan payment 300 300 300 300
Total cash outflows
Net cash flow
Closing balance
 Cash flow forecast exercise - ANSWERS
Sept ($) Oct ($) Nov ($) Dec ($)
Opening balance 1,300 1,050 1,300 625
Inflows
Cash sales 700 650 500 900
Credit sales 450 800 200 450
Total cash inflows 1,150 1,450 700 1,350
Outflows
Raw materials 400 200 375 600
Wages 500 500 500 500
Advertising 200 200 200 1100
Loan payment 300 300 300 300
Total cash outflows 1,400 1,200 1,375 2,500
Net cash flow (250) 250 (675) (1,150)
Closing balance 1,050 1,300 625 (525)
Analysing a cash flow forecast
Look at the completed cash 1. Describe the total cash
flow forecast from the inflow trend.
previous slide. 2. Describe the total cash
outflow trend.
3. Describe the net cash
flow trend.
4. Describe the closing
balance trend.
5. What conclusions can
you draw about the
liquidity position of this
company?
Over to you
• Hoang textbook
• Question 3.7.3 Pranab & Co.
• Page 315
• Question 3.7.4 Wincent
Wines
• Page 317
• Question 3.7.5 Menelao
Stationers
• Page 317
• Question 3.7.6 Bereti’s
Boutique
• Page 319
• Answer all questions
 The relationship between
investment, profit and cash
flow
Best and worst case financial outcomes
• The relationship between investment,
profit and cash flow must be managed
carefully.
• When managed well, a firm is likely to meet
its long-term objectives as its growth
strategies are underpinned by healthy
finances.
• When managed poorly, a firm will struggle
and eventually have to cease trading.
Best case financial outcome
Consistent positive net
cash flows lead to
healthy liquidity

Healthy liquidity allows

Consistent profits
for investment into
eventually lead to
fixed assets to
consistent positive net
maintain/increase
cash flows
output

Consistent (or better)

levels of output
generate consistent
profits
Worst case financial outcome
Consistent negative
net cash flows lead to
a poor cash balance

Reduced productivity A poor cash balance

leads to reduced prevents a firm from
profits or even losses, making ongoing
which causes negative investments into fixed
net cash flows assets

Lack of ongoing
investment into fixed
assets results in
reduced productivity
Strategies to deal with
cash flow problems
Common causes of cash flow problems
Causes Explanation
Overtrading This is when businesses accept more orders than it has the capacity to
financially handle.
Over-borrowing High levels of debt mean a firm has to increasingly use more of its cash
inflows to repay loans and interest charges.
Over-stocking Having more stock than the business is able to sell (i.e. convert into cash)
means that valuable cash is tied up as it is ‘stuck’ as inventory.
Poor credit Liquidity problems occur when firms:
control • Offer too many customers trade credit.
• Offer long trade credit terms.
• Chase debtors too slowly.
Unforeseen Liquidity problems occur when firms:
changes • Experience unexpected or erratic changes in demand (e.g. out-of-season
increases in demand).
• Experience unexpected expenditures (e.g. spoiled inventory due to
equipment failure).
Liquidity crisis at Hong Kong Airlines
Hong Kong Airlines (HX) has
been struggling with cash
flow problems since 2018.
1. Watch this video and
identify the strategies
used by HX to improve
its liquidity position.
2. Explain whether HX can
continue using these
strategies indefinitely.
3. Other than the strategies
identified from the
video, what else can HX
do to improve its
working capital position?
Reducing cash
outflows
• Methods of reducing cash outflows include:
• Seeking preferential credit terms
• Seeking alternative suppliers
• Better stock control
• Reduce expenses
• Leasing rather than buying
Increasing cash
inflows
• Methods of increasing cash inflows from revenues
include:
• Tighter credit control
• Accepting cash payments only
• Changing pricing policy
• Improving the firm’s product portfolio
Seeking
additional
sources of
finance
• Additional sources of finance appropriate for a liquidity crisis include:
• Overdrafts
• Selling fixed assets
• Debt factoring
• Government assistance
• Additional sources of finance will increase cash inflows into the business.
Over to you
• Hoang textbook
• Question 3.7.7
Ducie’s Dance Studios Ltd.
• Page 322
• Answer all parts
Cashflow and
the CUEGIS
concepts
Cash flow and CUEGIS
• Cash is largely regarded as more important than profit in
the short run.
• Failure to use cash-boosting and cost-reduction
strategies will result in the insolvency of a business.
• A contingency fund is important to manage any
unexpected impacts on cash flow, particularly changes
from the external environment.

• Innovation in stock management software

allows firms to keep a close eye on
overstocking.