CASHFLOW FORECASTING

Cash can be defined as notes, coins and money that a business has in its bank accounts

Why is cash important?

If a firm doesn’t have any cash to pay its workers, suppliers, landlord and government, the
business could go into liquidation– selling everything it owns (Assets) to pay its debts. The
business needs to have an adequate amount of cash to be able to pay for all its short-term
payments.

The management of cash is very important as cash allows a business to pay its bills. Therefore a
business may use cash for the following reasons:

 payments to suppliers
 payments to employees(wages and salaries)
 Overheads (indirect costs)- money spent regularly on rent, electricity and telephone bills to
make the business run.
 To prevent business failure-if a business runs out of cash it may become insolvent (unable to
pay debts).This would usually result in business closing down.
When a business has just a few large customers and they fail to pay on time, the business’ cash
flow position is badly affected because the business does not have money it was expecting to
have. This can lead to the business having financial difficulties and even failing.

There are two main instances when a business can suffer cash flow problems:

 As start-up capital-when large amounts of money need to be invested to get the business
started, for example to pay for equipment, initial stock, rent, insurance, hiring, training and
staff costs
 during rapid growth\overtrading, when the business needs to grow quickly but cannot keep
up with the cash being paid out, for example, if the business needs to find larger premises and
invest in making them ready to move into
If a business has customers who are not paying what they owe, this means that the business may
be unable to pay its own bills and may become insolvent.
 The differences between cash and profit

NB

Not all cash paid into a business is profit. A business must pay its costs from the money that
comes into it. Once all costs have been deducted from all revenue, the amount that is left is the
business’ profit.

Profit is therefore the surplus amount after total costs have been deducted from sales. It includes
all income and payments incurred in the year, whether already received or paid or to not yet
received or paid respectively.

Profit is usually calculated on an annual basis. However, calculating it monthly can help a
business by showing that it is solvent and indicating whether it will be able to achieve its profit
targets.
CASH FLOW
The cash flow of a business is its cash inflows and cash outflows over a period of time.

Cash inflows are the sums of money received by the business over a period of time. E.g.:
 sales revenue from sale of products
 payment from debtors– debtors are customers who have already purchased goods from the
business but didn’t pay for them at that time
 money borrowed from external sources, like loans
 the money from the sale of business assets
 investors putting more money into the business
Cash outflows are the sums of money paid out by the business over a period of time. Eg:
 purchasing goods and materials for cash
 paying wages, salaries and other expenses in cash
 purchasing fixed assets
 Repaying loans (cash is going out of the business) by paying creditors of the
business- creditors are suppliers who supplied items to the business but were not paid at the
time of supply.
NET CASH FLOW

This is the difference between cash inflows and cash outflows. A business will hope that most of
the time net cash flow is positive. This simply means that more cash flows in the business than it
flows out of the business. However, there will be times when the net cash flow is negative. This
means that a business may have to borrow some money to overcome of cash flow problems.

CASH FLOW FORECASTS

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.

Example of a cash flow forecast of a business for four months

The cash inflows are listed first and then the cash outflows. The total inflows and outflows have
to be calculated after each section.

The opening cash/bank balance is the amount of cash held by the business at the start of the
month
Net Cash Flow = Total Cash Inflow – Total Cash Outflow
 The net cash flow is added to opening cash balance to find the closing cash/bank balance– the
amount of cash held by the business at the end of the month. Remember, the closing cash/bank
balance for one month is the opening cash/bank balance for the next month!
The figures in bracket denote a negative balance, i.e., a net cash outflow (outflows >
inflows).

Uses of cash flow forecasts:

 When setting up the business the manager needs to know how much cash is required to set
up the business. The cash flow forecast helps calculate the cash outflows such as rent,
purchase of assets, advertising etc.
 A statement of cash flow forecast is required by bank managers when the business applies
for a loan. The bank manager will need to know how much to lend to the business for its
operations, when the loan is needed, for how long it is needed and when it can be repaid.
 Managing cash flow– if the cash flow forecast gives a negative cash flow for a month(s), then
the business will need to plan ahead and apply for an overdraft so that the negative balance is
avoided (as cash come in and the inflow exceeds the outflow). If there is too much cash, the
business may decide to repay loans (so that interest payment in the future will be low) or pay
off creditors/suppliers (to maintain healthy relationship with suppliers).
 Help when planning the business- careful planning in business is important. Cash flow helps
to clarify aims and improve performance.
 Helps in identifying cash shortages- a cash forecast can help the business to identify in
advance when a business might need to borrow cash. The forecast clearly shows how much
cash is left at the end of each month. This will help to identify when , or if, a bank overdraft
will be needed.

SOLUTIONS TO CASH FLOW PROBLEMS

When a negative cash flow is forecast (lack of cash) the following methods can be used to
correct it:

 Increase bank loans: bank loans will inject more cash into the business, but the firm will
have to pay regular interest payments on the loans and it will eventually have to be repaid,
causing future cash outflows
 Delay payment to suppliers: asking for more time to pay suppliers will help decrease cash
outflows in the short-run. However, suppliers could refuse to supply on credit and may reduce
discounts for late payment
 Ask debtors to pay more quickly: if debtors are asked to pay all the debts they have to the
firm quicker, the firm’s cash inflows would increase in the short-run. These debtors will
include credit customers, who can be asked to make cash sales as opposed to credit sales for
purchases (cash will have to be paid on the spot, credit will mean they can pay in the future,
thus becoming debtors). However, customers may move to other businesses that still offers
them time to pay
 Delay or cancel purchases of capital equipment\Assets: this will greatly help reduce cash
outflows in the short-run, but at the cost of the efficiency the firm loses out on not buying new
technology and still using old equipment.
Limitation of cash flow forecast
*Some of the financial information used in forecast will be based on estimates .For example even
under normal trading conditions it is very difficult to predict sales revenue for future period –it
has to be estimated. It is also difficult to estimate future costs especially variable costs. Therefore
,if the figures for cash inflows and cash outflows are not accurate, then the net cash flows and
closing balance will be unreliable when making decisions.
*External factors that are beyond business and managers control. Changes in factors such as
interest rates, the state of the economy, government legislation , competition and consumers
taste can have an impact on business costs and revenues. As a result, there will be an impact on a
cash flow forecast .For example sales revenue would be affected negatively if competition
becomes stiff in the market
*Recourses are used in preparing a cash- flow forecast. A business owner or employee will
spend time gathering information .There might be a danger, for example the owner spends too
much time and resources on the cash flow-flow forecasts at the expense of meeting customer
needs.
THE END