Head to savemyexams.

com for more awesome resources

CIE IGCSE Business Your notes

5.2 Cash-flow Forecasts & Working Capital

Contents
Using Cash-flow Forecasts
Solving Short-term Cash-flow Problems
T he Importance of Working Capital

Page 1 of 15

© 2015-2024 Save My Exams, Ltd. · Revision Notes, Topic Questions, Past Papers
 Head to savemyexams.com for more awesome resources

Using Cash-flow Forecasts

Your notes
The Importance of Cash to a Business
Cash is the 'blood' of a business, as without it, a business will die
It is a liquid asset in the form of notes, coins and money in the bank

A profitable business is likely to fail if it does not have sufficient cash

Cash-poor businesses will struggle to pay suppliers, employees and operating expenses
This is called insolvency
E.g. Lifestyle retailer Joules announced plans to liquidate in December 2022 as a result of
cash-flow difficulties despite making a profit of £2.6 million during the previous year
A new business may have to pay cash on purchase for all of its supplies until its suppliers trust
them enough to provide credit terms (buy now, pay later)
A supplier may then give the business trade credit of 30 or 60 days
This means that the business can receive their stock now and only pay for it in 30 or 60 days;
the cash outflow is delayed
As the business sells its products, they receive money generated from the business revenue
and this represents a cash inflow
At the end of 60 days they will pay their supplier (cash outflow), but the firm may still have half
of its stock available for sale

A cash flow cycle shows the stages between paying out cash for labour, materials, and so on, and
receiving cash from the sale of goods

Diagram to show a Cash-flow Cycle

Page 2 of 15

© 2015-2024 Save My Exams, Ltd. · Revision Notes, Topic Questions, Past Papers
 Head to savemyexams.com for more awesome resources

Your notes

Explanation of cash-flow cycle

The diagram shows that cash is needed to pay for materials used to produce the product
Time is needed to produce the products before they can be sold to customers
If customers purchase the goods using a credit facility provided by the business, then they
will not have to pay immediately, which will delay cash inflows
When they do pay for the goods immediately, this money will be used to pay business expenses
Due to the time between each stage, the business needs to make sure it has enough working
capital to keep running and pay bills

Businesses, particularly start-ups, need to ensure that they manage cash-flow to ensure that it
does not run out of money

Cash-flow issues may put the business in a situation where it is

Page 3 of 15

© 2015-2024 Save My Exams, Ltd. · Revision Notes, Topic Questions, Past Papers
 Head to savemyexams.com for more awesome resources

Unable to pay key stakeholders, such as workers and suppliers

Production is likely to cease as workers will not work without pay and suppliers will not
supply goods if they are not paid Your notes
Unable to pay utility bills and rent

The business could be forced into liquidation and, ultimately, is likely to fail

Page 4 of 15

© 2015-2024 Save My Exams, Ltd. · Revision Notes, Topic Questions, Past Papers
 Head to savemyexams.com for more awesome resources

Constructing a Cash-flow Forecast

A cash-flow forecast is a prediction of the anticipated cash inflows and cash outflows typically Your notes
for a three, six or twelve month period
Typical outflows include payments for raw materials, paying staff wages and salaries, paying
bills such as electricity and repaying loans
Typical inflows include receipts from sales, money received from a new bank loan, money
from the sale of an asset and money from investors

Diagram: Example of a Three-month Cash-flow Forecast

The three month cash-flow forecast clearly shows how inflows and outflows of cash into a business are
accounted for

Page 5 of 15

© 2015-2024 Save My Exams, Ltd. · Revision Notes, Topic Questions, Past Papers
 Head to savemyexams.com for more awesome resources

Steps in constructing a cash-flow forecast

The business starts with an opening balance of £500 in January Your notes
Total inflows for January are £8,600
Total outflows are expected to be £4,770
The Net Cash-flow is expected to be £3,830 (£8,600 - £4,770)
January’s closing balance is expected to be £4,330 (£500 + £3,830)
Each closing balance becomes the opening balance for the next month
As the closing balance for January is £4,330, the opening balance for February is therefore
£4,330

The calculation process starts again in February, and every month onwards
Net cash flow + opening balance = closing balance

The bank account balance is positive after three months but is decreasing month on month,
which may suggest there will be cash-flow problems in the months ahead
The importance of cash-flow forecasts
By analysing cash flow over time, businesses can better plan and allocate financial resources
E.g. Problematic months can be identified early and sources of additional finance put in
place to ease the cash-flow

Cash flow forecasts are useful in the following situations

Starting up a business: identifying how much cash is needed in the first few months
Running an existing business: recognising where a fall in sales may require use of an overdraft
facility
Supporting applications for borrowing: determining the siz e of loan or overdraft needed,
when and for how long it is needed and by when it is likely to be fully repaid
Managing transactions: identifying how much or how little cash is deposited at the bank can
determine when bills should be paid

Page 6 of 15

© 2015-2024 Save My Exams, Ltd. · Revision Notes, Topic Questions, Past Papers
 Head to savemyexams.com for more awesome resources

Calculating & Interpreting Cash-flow Forecasts

It is important for a business to know how to calculate and interpret a cash-flow forecast Your notes
An Example of a Start-up 3 Month Cash Flow Forecast (£s)

Jan Feb Mar

Inflows

Cash received from sales 4,600 5,100 3,100

Total inflows 4,600 5,100 3,100

Outflows

Inventory/stock 1,500 850 900

Wages 2,200 2,200 2,200

Utilities 840 840 840

Total outflows 4,540 3,890 3940

Net cash flow 60 1,210 (840)

Opening balance 500 560 1770

Closing balance 560 1,770 930

Cash-flow forecast analysis

Executive Summary
Overall, this cash flow forecast supports a decision for the business to arrange an overdraft
facility with their bank
As sales increase in January and February, inflows are greater than outflows, and the business has
a positive cash flow
This changes in March as the level of sales falls and the net cash flow turns negative
An overdraft facility will help them survive if their closing balance drops below z ero in the next
month or two

Page 7 of 15

© 2015-2024 Save My Exams, Ltd. · Revision Notes, Topic Questions, Past Papers
 Head to savemyexams.com for more awesome resources

January
The opening balance of £500 has been introduced by the owner Your notes
The business is expected to achieve sales of £4,600
Total outflows are expected to be £4,540
The Net Cash Flow is expected to be £60 (£4,600 - £4,540)
January’s closing balance is expected to be £560 (£60 + £500)
February
The closing balance from January becomes the opening balance for February
Sales of £5,100 are expected to be the business total inflows
Total outflows are expected to be £3,890
The net cash flow is expected to be £1,210 (£5,100 - £3,890)
The closing balance is expected to be £1,770 (£1,210 + £560)
March
The closing balance from February becomes the opening balance for March
The business expects to achieve sales of £3,100 as its total inflows
Total outflows are expected to be £3,940
The net cash flow is expected to be -£840 (£3,100 - £3,940)
The closing balance is expected to be £930 (-£840 + £1,770)

Page 8 of 15

© 2015-2024 Save My Exams, Ltd. · Revision Notes, Topic Questions, Past Papers
 Head to savemyexams.com for more awesome resources

Worked example
Your notes
The following is an extract from a cash flow forecast

April May June

000s 000s 000s
Cash inflow 23 24 30
Cash outflow 28 81
Net cash flow 10 (51)
Opening bank balance 30 40 36
Closing bank balance 40 36

Fill in the three blanks to complete the cash flow forecast. (3)

Step 1: Calculate the cash outflow for April

Net cash flow = Cash inflow − Cash outflow

(1 mark)
£ 10, 000 = £ 23, 000 − £ 13, 000

Step 2: Calculate the net cash-flow for May

Net cash flow = Cash inflow − Cash o utflow

Net cash flow = £ 24, 000 − £ 28, 000 (1 mark)

Net cash flow = − £ 4, 000

Step 3: Calculate the closing balance for June

Page 9 of 15

© 2015-2024 Save My Exams, Ltd. · Revision Notes, Topic Questions, Past Papers
 Head to savemyexams.com for more awesome resources

Closing balance = Opening balance + n et cash flow

(1 mark) Your notes

Closing balance = £ 36, 000 + − £ 51, 000

Closing balance = − £ 15, 000

Exam Tip
When calculating opening and closing balances, work through each month in turn. Always
double-check your calculations in cash-flow forecasts, as one mistake will have a knock-on
effect elsewhere and may lead you to make inaccurate judgements

Page 10 of 15

© 2015-2024 Save My Exams, Ltd. · Revision Notes, Topic Questions, Past Papers
 Head to savemyexams.com for more awesome resources

Solving Short-term Cash-flow Problems

Your notes
Overcoming Short-term Cash-flow Problems
Liquidity is the ability of a business to meet its short-term commitments (e.g. payments to
creditors) with its available assets
A business that cannot pay its bills will usually fail very quickly, even if they are profitable
Managing liquidity is a key way to manage risk in a business and helps a business prepare for
the unexpected

Many businesses experience short-term cash-flow problems

Start-ups initially have high costs and low sales revenue
Existing firms may unexpectedly receive a large order that requires them to buy and pay for a
large amount of raw materials

There are several ways in which a short-term cash-flow problem can be resolved
Diagram: Solving Short-term Cash-flow Problems

Page 11 of 15

© 2015-2024 Save My Exams, Ltd. · Revision Notes, Topic Questions, Past Papers
 Head to savemyexams.com for more awesome resources

Your notes

Asking a supplier to increase the amount of trade credit they offer is one popular solution to ensure raw
materials keep flowing into the business

A business often uses more than one method to ensure cash-flow remains positive, e.g.
combining an overdraft and reducing the time period available for their customers to pay them
The Methods used to Overcome Short-term Cash-flow Problems

Method Explanation

Seek to increase the The business may approach some of its most trusted suppliers and
trade credit period ask them for more generous repayment terms
E.g. They may request their suppliers to extend the repayment
period from 30 days to 90 days

Page 12 of 15

© 2015-2024 Save My Exams, Ltd. · Revision Notes, Topic Questions, Past Papers
 Head to savemyexams.com for more awesome resources

Shorten debtor If the business offers customers the ability to 'buy now, pay later', this
repayment periods delays the cash inflow. Removing the option to pay later will improve
cash-flow Your notes
However, the business may lose some customers to competitors
who are able to keep offering credit terms

Apply for a bank loan Businesses can often arrange short-term bank loans in a very short
time frame, ofetn a couple of days
Interest will have to be paid

Delay plans to Postponing the purchase of new equipment, such as vehicles, may
purchase new significantly reduce cash outflows
equipment

Only sell in cash, not Businesses can choose to only accept cash as payment, meaning it
credit receives money immediately
Customers may buy from competitors that sell on credit instead

Overdraft facility Temporary cash-flow problems can be solved by arranging to spend

more than the businesses current account balance
Interest rates may be relatively high, increasing business costs

Page 13 of 15

© 2015-2024 Save My Exams, Ltd. · Revision Notes, Topic Questions, Past Papers
 Head to savemyexams.com for more awesome resources

The Importance of Working Capital

Your notes
An Introduction to Working Capital
Working capital is the money that a business has available to fund its day-to-day activities
It is calculated using the formula
Working Capital = Current Assets - Current Liabilities

Current assets include cash, cash equivalents or assets which can be converted to cash within a
one year period
Cash
Debtors
Inventories (stock)

Current liabilities are short-term financial obligations that are usually repayable within one year, or
as demanded by creditors
Creditors
Short-term loans
Overdrafts

Page 14 of 15

© 2015-2024 Save My Exams, Ltd. · Revision Notes, Topic Questions, Past Papers
 Head to savemyexams.com for more awesome resources

The Importance of Working Capital

Working capital is vital to the day-to-day operation of a business Your notes
A lack of working capital often leads to business failure if the business cannot meet its
immediate financial obligations
Cash is the most liquid of a business's current assets and can be used to settle debts
immediately
Stock takes time to be sold and converted to cash to pay debts so is the least liquid current
asset

Effective management of working capital involves careful cash management

If the finance manager is able to balance the flow of money in and out of the business, then the
business is more likely to grow and be successful
A business can hold too little or too much cash, both of which cause different issues

The Problems of a Shortage or Excess of Working Capital

Shortage of Working Capital Excess of Working Capital

Businesses may look to convert debtors and Holding large amounts of cash may mean
stock into cash as quickly as possible. This missing out on benefits of investing it in fixed
is achieved by selling stock at low prices or by assets or investments
purposefully chasing payment from
customers This may represent a significant [popover
id="rwgdJTaybPhZJ4sJ" label="opportunity
Requesting an extension of trade credit cost"], as the money is not being put to work
terms from suppliers can increase working for the business
capital in the short term, as cash remains in the
business for longer If a business is holding large amounts of
stock, it may incur extra storage costs, and
Making use of short-term borrowing the cash value of the stock could be used for
options such as overdrafts can improve a other purposes
businesses working capital situation as it can
access more cash than it has in its current
account

Page 15 of 15

© 2015-2024 Save My Exams, Ltd. · Revision Notes, Topic Questions, Past Papers