Cash Flow Forecasting and

Working Capital
Why is cash important?
If a firm doesn’t have any cash to pay its workers, suppliers, landlord and government, the
business could go into liquidation– selling everything it owns to pay its debts. The business
needs to have an adequate amount of cash to be able to pay for all its short-term payments.
Cash Flow
The cash flow of a businesses is its cash inflows and cash outflows over a period of time.
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
 investors putting more money into the business
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.
The cash flow cycle:
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Cash flow 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.
Cash Flow Forecasts
A cash flow forecast is 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. 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
Example of a cash flow forecast for the four months:

The cash inflows are listed first and then the cash outflows. The total inflows and outflows
have to be calculated after each section.

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
The net cash flow is added to opening cash balance to find the 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!
The figures in bracket denote a negative balance, i.e., a net cash outflow (outflows > inflows)

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).

How can cash flow problems be overcome?

When a negative cash flow is forecast (lack of cash) the following methods can be used to
correct it:

 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
 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
 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.
Working Capital
Working capital the capital required by the business to pay its short-term day-to-day
expenses. Working capital is all of the liquid assets of the business– the assets that can be
quickly converted to cash to pay off the business’ debts. Working capital can be in the form
of:
 cash needed to pay expenses
 cash due from debtors – debtors/credit customers can be asked to quickly pay off what
they owe to the business in order for the business to raise cash
 cash in the form of inventory – Inventory of finished goods can be quickly sold off to
build cash inflows. Too much inventory results in high costs, too low inventory may
cause production to stop.