5.3 FORECASTING AND MANAGING CASH FLOWS

• Cash flow


  The sum of cash payments to a business (inflows) less the sum of cash payments (outflows)
• Liquidation


  When a firm ceases trading, and its assets are sold for cash to pay suppliers and other creditors
• Insolvent


  When a business cannot pay its debts
• Why cash flow is important to a firm

  • You need cash to pay for the bills and expenses of running a business, not just profit
  • You cannot do much without cash, thus, you need to know where and when your money is coming from and coming in and what you are paying or where your money is going
• Profitable businesses


  Can run short on cash
• Loss-making businesses


  Can have cash inflows in the short term
• Importance of cash


  • Without cash, the business will cease - no cash to pay workers, suppliers will stop providing materials, banks will call in loans, shareholders will withdraw, utilities will be cut off
• Costs of holding too much cash

  • Opportunity costs - money could be invested to earn more
  • Loss of purchasing power if inflation rate is growing faster than interest rate
• Costs of holding too little cash

  • Inability to meet creditors' demands, need to borrow at expensive rates
• Possible causes of cash flow problems

  • Overtrading
  • Holding too much stock
  • High borrowing
  • Allow too many goods to be bought on credit
  • Businesses that rely on seasonal trade
  • High unemployment
• Firms that are making profit can be forced to close down
• Profit


  Does not necessarily mean "making a lot of money" - it depends on when cash payments are received
• How to forecast cash flow


  1. Forecasting cash inflows (owner's capital, bank loan, customer cash purchases, trade receivables)

  2. Forecasting cash outflows (lease payments, rent, utilities, labour costs, variable costs)
• Structure of cash flow forecasts

  • Forecasting cash inflows

  2. Forecasting cash outflows

  3. Net monthly cash flow

  4. Opening and closing balances
• Revising cash flow forecast

  Cash sales forecast to be $1000 higher

  2. Stock purchases forecast to be $500 higher

  3. Advertising forecast to be $100 higher
• Benefits of cash flow forecasting


  • Helps identify negative cash flows so additional finance can be sought

  Allows actions to be taken to improve cash flow

  Required for new business proposals to progress
• Limitations of cash flow forecasting

  • Mistakes in revenue and cost forecasts

  Unexpected cost increases

  Wrong assumptions about sales
• Causes of cash flow problems

  • Lack of planning

  Poor credit control

  Allowing customers too long to pay debts

  Expanding too rapidly

  Unexpected events
• Ways to improve cash flow

  • Increase cash inflows: Overdraft, short-term loan, sell idle assets, keep less stock, reduce credit terms, encourage early payment, debt factoring, reduce prices

  Reduce cash outflows: Delay payments to suppliers, delay capital spending, use leasing, cut overhead spending, sub-contracting