C HAPTER 23

C ASH FLOW FORECASTING AND

WORKING CAPITAL
5.2 B USINESS F INANCE : N EEDS AND R ESOURCES

In this topic you will learn about

 Why cash is important to a business

 What a cash-flow forecast is, how a simple one is constructed and

the importance of it

 Amend or complete a simple cash-flow forecast

 How to interpret a simple cash-flow forecast

 How a short-term cash-flow problem might be overcome, e.g.

increasing loans, delaying payments, asking debtors to pay more
quickly
 T HE IMPORTANCE OF CASH

In business a common quote is:

“Cash is King”
Businesses need cash to survive.
Spending on credit is often more
expensive.

Understanding the importance of cash and

the dangers of spending on credit is
important in life as well as business.
 T HE NATURE OF CASH FLOW

Cash flows into AND out of a business

Cash sales Purchasing stock

Payments from debtors Paying wages
Owners’ capital invested Paying debts – bank loans,
Sale of assets creditors
Bank loan Purchasing assets

Cash flow is interested in the balance between these cash inflows

and cash outflows in terms if their relative size and timings.
 C ASH FLOW

 Cash is important to a business

 Without cash it can not survive in the medium to long run

What is meant by
 Without cash it can not:
the term
liquidation?  Pay suppliers

 Buy new raw materials or stock

 Pay workers

 Operate machinery

 Market its products

 Cash flow problems exist when a business has a negative

cash balance at the end of a period e.g. a month
 CASH FLOW

If cash outflow is higher than cash inflow over a period of time then
cash in hand will decrease. At some point it may run out. This is
when the business has cash flow problems.

A business with a positive cash flow can meet all of its day to day
expenses. It can also save for future growth and take advantage of
opportunities that arise e.g. additional stock or sponsoring an event.
 CASH FLOW

 Cash flow statements

 A record of all the cash flowing into and out of the business

 Shows opening balance at start of each month and closing

balance at end

 Normally produced monthly but can be any time frame e.g.

If the closing
weekly
balance at the end
of January is $1500  Opening balance
what is the opening
balance for  Cash available at the start of the month
February?
 Closing balance
 Cash available at the end of the month
 CASH FLOW

Cash flow statements

Can you explain
what is meant by  Cash flow
credit sales and
credit purchases?  The movement of money in and out of a business over a period of time

 Cash in

 Money that flows into the business

 Receipts
 Cash sales
 Receipts from earlier credit sales

 Cash out

 Money that flows out of the business

 Purchases
 Cash purchases
 Payments for earlier credit purchases
 Q UESTION TIME

The owner of a florists is completing a cash flow

forecast and wants to identify cash inflows for
the business.

Which two of these are cash inflows?

Personal
Annual rent Delivery van
investment

Staff wages Sales income Web design

 CASH FLOW

 Net cash flow

 The difference between total cash in and total cash out

 Total cash in = $2000, total cash out = $1400, Net cash

flow = $600 i.e. $600 more flowed in than out

Quick recap before moving on

Do you understand the following terms?
Cash in Receipt Cash out
Payments Credit sales Credit purchases
Opening balance Closing balance
Net cash flow Cash flow statement
 CASH FLOW FORECAST

 Cash flow forecast

 The process of predicting the future cash inflows and outflows

 Allows a business to identify any potential negative closing balances in

advance and therefore take action:
 Speed up or increase cash inflows
 Slow down or reduce cash outflows
 Arrange an overdraft

 Can monitor actual cash flow against predicted

 Can help set targets for future years

 Allows a business to identify positive closing balances

 If too high this may be seen as being too careful
 Could look for opportunities to reduce the closing balance e.g. gain new
customers by offering longer payment terms
 Could be used to grow the business or earn a higher rate of interest
 T HE NATURE OF CASH FLOW

 A cash flow forecast is a forward looking statement

that tries to predict cash inflows and outflows in the
future

 Cash flow forecasts are an important part of a

business plan

Cash flow problems can lead to business failure (Insolvency).

A business that cannot pay its short term debts is in danger of becoming
an ex-business!
 H OW TO FORECAST CASH FLOW – A
PREDICTION OF THE MONTHLY INFLOWS AND
OUTFLOWS

 Cash inflows
 Owner’s investment or other source of finance
 Cash sales estimated from sales forecast
 May be over or under estimated
 To some extent depends upon the scale of
research
 More difficult for new businesses
 Debtor payments estimated from sales forecast
 Determined by credit terms offered to
customers
 H OW TO FORECAST CASH FLOW – A
PREDICTION OF THE MONTHLY INFLOWS AND
OUTFLOWS

 Cash outflows

 Payment of fixed costs

 These should be easy to estimate on a monthly basis

 Payment of variable costs

 If sales are difficult to forecast logically so must the costs associated with
meeting them

 Made more difficult if suppliers are free to change the prices

 Unforeseen expenses
 Or just forgotten expenses! A new entrepreneur may find it difficult to
estimate how much they will be

 Payment terms
 What if a supplier changes terms and wants payment sooner or a lender
demands their money back
 F ILLING IN A CASH FLOW FORECAST

Jan Feb Mar

Receipts ($) 10 000 15000 17500
Payments
Add the Raw materials 3500 4000 5500
costs to get
Total Fixed costs 5000 5000 5000
Payments
Other costs 4000 4500 5000
Total payments 12500 13500 15500
Receipts
minus Total
Payments =
Net cash flow (2500) 1500 2000
NCF () denote a
Opening balance 2000 (500) negative figure 1000
Closing balance (500) 1000 3000

• Cash inflows (Receipts) – cash outflows (Payments) = Net Cash Flow

• Net cash flow + opening balance (start of month) = closing balance (end of month)
 F ILLING IN A CASH FLOW FORECAST
– YOUR TURN

You may be asked to fill in the blanks on a cash flow

forecast. See if you can do it here.

Jan Feb Mar

Receipts ($) 8000 6000 e
Payments
Raw materials 3000 c 4000
Fixed costs 2500 2500 2500
Other costs 4000 3000 3500
Total payments a 8000 10000
Net cash flow b (2000) (500)
Opening balance 1000 (500) (2500)
Closing balance (500) d (3000)
 T HE I MPORTANCE OF C ASH F LOW F ORECASTS

 Cash Flow Forecasts

 Businesses normally produce a forecast of their
expected cash flow before the start of the year

 This allows them to spot any potential cash shortfalls

in advance

 They can then look to avoid this

 They can then make plans for this i.e. a pre arranged
overdraft

 Can monitor actual cash flow against predicted

 T HE I MPORTANCE OF C ASH F LOW F ORECASTS

 Identifies negative closing balance

 If you are aware of this you can try and act
 Reduce or speed up cash outflows
 Increase or slow down cash outflows
Its not as easy as it sounds! We look more at these options shortly

 Identifies positive closing balance

 Is too much cash sat dormant when it could be used to grow
the business or earn a higher rate of interest
If you were a business with a high closing balance at the end of each
month what would you do with it?
 Can help set targets for future years
 Monitor actual cash flow against forecast
 C ASH F LOW

Look at the businesses listed below and consider how likely they are to have
cash flow problems.
Remember it is not about how much profit the business may or may not make
but whether they will have enough cash on a day to day basis to meet
expenses.
Place these businesses in a rank order - 1 being most likely to have cash flow
problems and 7 least. Justify your ranking.

Business Ranking Justification

Fruit stall on market
Christmas tree grower
Taxi company
Second hand car lot
PYO fruit farm
Travel agent
Window cleaner
 C ASH F LOW F ORECAST

A cash flow forecast for the first 4 months of Geoffrey’s farm shop.

Jan ($) Feb ($) Mar ($) Jun ($)

Inflow 4 000 4 500 5 500 6 500

Outflow 13 000 2 250 2 000 2 500

Net cash flow - 9 000 2 250 3 500 4 000

Opening 0 -9 000 -6 750 -3 250

Balance
Closing Balance - 9 000 -6 750 -3 250 750

Can you explain the following figures?

Why is his opening balance $0 in January?
Why might cash out be so high in January?
Why might cash in be lower in January than other months?
 C ASH F LOW F ORECAST

Jan ($) Feb ($) Mar ($) Jun ($) Complete

Inflow 8 000 9 000 9 000 10 000 the cash
flow forecast
Cost of 5 000 4 500 4 500 4 000
sales
Utilities 1 500 1 500 1500 1 500

Other costs 2 500 1 000 600 500

Net cash
flow
Opening 0
Balance
Closing -1 000
Balance
 C ASH F LOW

Bridget and Brendan run a small B&B in Brighton. During the summer
months business is booming but earlier in the year Bridget struggles to
make ends meet. She has bills to pay and a mortgage on the B&B but
is lucky to have one or two paying customers per week. Brendan tells
her not to worry as bookings for the summer are being made fast and
they look likely to be fully booked from May right through to
September. Bridget is worried this may be too late and tells Brendan
“it is right now that we have cash flow problems”.

Question time
1. What is meant by the term ‘cash flow problem’?
2. Explain the cause of Bridget and Brendan’s cash flow problem.
3. Is Bridget right to be so concerned? Justify your answer.
 S OLUTIONS TO C ASH F LOW P ROBLEMS

 If a business does have cash flow problems this

can be serious and they may need to take
corrective action

 By serious we mean very serious as businesses

do fail as a result of cash flow problems
 What would happen if at the end of the week
there was not enough cash to pay the workers,
purchase new stock, fill the van with petrol etc?

 So it is important to look for solutions

 Can you think of any solutions?
 S OLUTIONS TO S HORT - TERM C ASH F LOW
P ROBLEMS

 Slow down money flowing out of the business

 Negotiate credit terms with suppliers e.g. buy now pay in 30 days

 Can you think of any possible problems with this?

 Reduce amount of money flowing out

 Can you reduce costs e.g. find a cheaper supplier

 Can you think of any possible problems with this?

 Speed up money flowing in

 Get customers and debtors to pay quicker or possibly in advance e.g. pay a deposit

 Can you think of any possible problems with this?

 Increase money flowing in

 Take out a loan

 Attract more customers – but how?

 Can you think of any possible problems with this?

 Q UESTION TIME

Syed is the owner of a barber shop. He has produced

the following cash flow forecast for the first three
months.
Jan ($) Feb ($) Mar ($)
Total receipts 6000 6000 6500
Total payments 4000 4500 5000
Net Cash flow 2000 1500 1500
Opening 500 2500 4000
balance
Closing balance 2500 4000 5500

Syed has forgotten to include $400 per month for staff

wages. Using this information update the cash flow forecast
for his barbers.
 W ORKING C APITAL

In this topic you will learn about

 The concept and importance of working capital
 W ORKING CAPITAL

 Working capital is the money used to run the day

to day activities of a business

 It is calculated from the statement of financial

position (balance sheet)
 Current assets – current liabilities

 If the working capital is negative the business

may have problems with funding day to day
activities
 A NALYSE FINANCIAL S TATEMENTS

 A business will look at working capital as a measure of performance

 Working capital = the money available to meet day to day
expenses
 Working capital = current assets – current liabilities
 To improve working capital a business must either
 Increase _______________
 Decrease _______________
In pairs complete the table below to identify how a business could
increase working capital.
Increase or How?
decrease?
Stock
Trade receivables
Cash
Trade payables
Overdraft
 S TATEMENT OF FINANCIAL POSITION EXTRACT

You will learn

more about
statements of  Calculate the working capital
financial position Non-current Assets $ms
and the terms Non-current Assets 62 62
used here in 5.4. Current Assets
Inventory 30
Trade receivables a
Cash 9 60
Current Liabilities
Trade payables 42
Overdraft 8 b

Working capital =
 W ORKING C APITAL

 For most businesses the important element of working capital is:

 Trade receivables. These are the short-term bills that have yet to be paid by
customers

 Trade payables. These are the short-term bills that the business has yet to pay
to suppliers

 If a business cannot finance its trade payables it is at risk of going

out of business

 This means that the business will keep a tight control on its trade
receivables
 W ORKING C APITAL

A business must have working capital in order to operate on a daily basis. To do this a
business can:

 Try to avoid late payments from customers by managing trade receivables

 Ensure cash is available to pay day to day expenses

 Do not use short-term finance to purchase non-current assets as these assets

cannot easily be converted back to help pay short-term debts

 Manage inventory effectively. For example, Just-in-Time can be used to ensure

that stock is not wasted

 Manage your inventory. Try to avoid under-stocking and over-stocking. Many

manufacturers use just-in-time (J.I.T.) basis for inventory because it is cost-
effective, uses less inventory space, less stock-holding, and reduces damaged
stock.