Cash-flow forecast and working capital

• Cash-flow forecast


  Prediction of the anticipated cash inflows and cash outflows typically for a three, six or twelve month period
• Working capital


  The money that a business has available to fund its day-to-day activities
• Cash is the 'blood of a business, as without it, a business will die
• Cash


  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
• Insolvency


  When a business does not have sufficient cash to pay its debts
• Example of cash-flow difficulties

  • 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
• Cash-flow cycle


  Paying out cash for labour, materials, and so on, and receiving cash from the sale of goods
• 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)
• Trade credit


  When a supplier gives the business 30 or 60 days to pay for the stock they have received
• 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
• Steps in constructing a cash-flow forecast

  1. Start with an opening balance

  2. Calculate total inflows

  3. Calculate total outflows

  4. Calculate net cash flow

  5. Calculate closing balance
• Net cash flow


  Inflows - Outflows
• Despite negative net cash flow between February and May, this businesses closing balance is expected to remain positive during the period, suggesting it does not expect to suffer cash flow problems
• Importance of cash-flow forecasts

  • Helps businesses plan and allocate financial resources
  • Identifies problematic months early and sources of additional finance can be put in place
• Situations where cash-flow forecasts are useful

  • Starting up a business
  • Running an existing business
  • Supporting applications for borrowing
  • Managing transactions
• An overdraft facility will help the business survive if their closing balance drops below zero in the next month or two
• Liquidity


  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
• Ways to overcome short-term cash-flow problems

  • Increase the period of trade credit
  • Shorten debtor repayment periods
  • Apply for a bank loan, use of overdraft facility
  • Delay plans to purchase new equipment
  • Customers pay at point of purchase and not on credit
• Working capital


  The money that a business has available to fund its day-to-day activities, calculated as Current Assets - Current Liabilities
• Current assets


  • Cash
  • Cash equivalents
  • Assets which can be converted to cash within a one year period
• Current liabilities


  • Creditors
  • Short-term loans
  • Overdrafts
• Importance of working capital

  • Vital to the day-to-day operation of a business
  • 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
• Problems of a shortage or excess of working capital

  • Shortage: Businesses may have to sell stock at low prices, suppliers may not allow trade credit extensions, businesses may have to use high-interest short-term borrowing
  • Excess: Businesses may miss out on benefits of investing excess cash, may incur extra storage costs for excess stock