Cash flow forecasting and working capital

• The cash flow of a business is the cash inflows and outflows over a period of time.

  If a business has too little cash – or even runs out of it completely – it will face major problems, such as:

  • being unable to pay workers, suppliers, landlord, government
  • production of goods and services will stop – workers will not work for no pay and suppliers will not supply goods if they are not paid
  • the business may be forced into ‘liquidation’ – selling up everything it owns to pay its debts.
• Cash inflows are the sums of money received by a business during a period of time.

  How can cash flow into a business (cash inflow)?

  • The sale of products for cash.
  • Payments made by debtors
  • Borrowing money from an external source
  • The sale of assets of the business,
  • Investors, for example, shareholders in the case of companies, putting more money into the business.
• Cash outflows are the sums of money paid out by a business during a period of time.

  How can cash flow out of a business (cash outflow)?

  • Purchasing goods or materials for cash.
  • Paying wages, salaries and other expenses in cash.
  • Purchasing non-current (fixed) assets.
  • Repaying loans.
  • By paying creditors of the business – other firms which supplied items to the business but were not paid immediately.
• 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.

  
• Can profitable businesses run out of cash? Yes – and this is a major reason for businesses failing. It is called insolvency.How is this possible?

  • expanding too quickly and keeping a high inventory level. This means that cashis used to pay for higher inventory levels. This is often called overtrading.
  • purchasing too many non-current (fixed) assets at once.
  • allowing customers too long a credit period, perhaps to encourage sales.
• 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.

  • How much cash is available for paying bills, repaying loans or for buying fixed assets.
  • How much cash the bank might need to lend to the business in order to avoid insolvency.
  • Whether the business is holding too much cash which could be put to a more profitable use.
• Uses of cash flow forecasts:

  • Starting up a business.
  • Keeping the bank manager informed.
  • Managing cash flow.
  • Running an existing business.
• • Net cash flow is the difference, each month, between inflows and outflows.
  • Closing cash (or bank) balance is the amount of cash held by the business at the end of each month. This becomes next month’s opening cash balance.
  • Opening cash (or bank) balance is the amount of cash held by the business at the start of the month.
• How a short-term cash flow problem might be overcome:

  
• Working capital is the capital available to a business in the short term to pay for day-to-day expenses.
• Working capital = Current assets – Current liabilities
• Working capital may be held in different forms:

  • Cash is needed to pay day-to-day costs and buy inventories.
  • The value of a firm’s debtors is related to the volume of production and sales.To achieve higher sales there may be a need to offer additional credit facilities.
  • The value of inventories is also a significant part of working capital. Not havingenough inventories may cause production to stop. On the other hand, a very high inventory level may result in high opportunity costs.