BUSINESS

MANAGEMENT
3.7.Cash flow
3.7.1.THE IMPORTANCE OF
CASH FLOW
➤ Cash is always important (in the short and long term).
➤ Cash flow relates to the timing of payments to workers and
suppliers and receipts from customers.
➤ A company has to establish a planning of the payment’s times
in order to avoid running out of cash (even though it is
➤
operating profitably)
If suppliers and creditors are not paid in time, they can force the
business into liquidation (a firm ceases trading) of its assets if
➤
it appears to be insolvent (a business cannot meet its short-
term debts).
Finance managers have to control the weekly or monthly net
cash flow (the sum of cash payments received (inflows) less
➤
the sum of cash payments made by it (outflows))
Cash flow control is especially important to new businesses
3.7.2.CASH AND
PROFIT
➤Profit is the difference between the revenue and the cost of goods sold (the profit
➤ and loss account). Cash has two components:
➤ Cash outflows: Payments in cash made by a business such as those to suppliers
and workers.
➤
Cash inflows: Payments in cash received by a
business, such as those from customers (debtors) or form the
➤ Some companies operate with losses but with high
bank (receiving a loan).
cash inflows.
3.7.3.WORKING
CAPITAL
➤All businesses need finance to pay for everyday expenses. Without sufficient working
capital a business will lack liquidity (be illiquid = unable to pay its short-term
debts).
➤
It comes from the difference between current assets (stocks, debtors and
cash) and current liabilities.
➤
Most businesses will obtain some of the finance to purchase current assets from
current liabilities elements (overdrafts, creditors, short-term loans, etc.). But not
always a business can obtain all the funds needed.
➤
Some businesses prefer not financing all their current assets with current liabilities
with the aim of having working capital for buying additional stocks or giving credit
➤
to customers (debtors).
Too high a level of working capital is a disadvantage (too much stocks, debtors
➤
and cash = opportunity cost (due to a lack of investment in fixed assets).
The working capital requirement for any business will depend of the length of the
working capital cycle (period of time between spending cash on the production
➤
process and receiving cash payments from customers) -> Període mitjà de
➤ maduració econòmic
The longer this working capital cycle, the greater will be the working
capital needed.
3.7.4.CASH FLOW
FORECASTS
➤ Forecasting cash flow is estimating future
cash inflows and cash outflows,
➤
usually on a month-by-month basis.
The business owner will probably start by attempting to
forecast
➤ Ex:
cash inflows first.
Owners’ own capital injection, bank
loan payments (agreed with the bank),
➤
customers’ cash purchases and debtors’ payments
The➤ business has to forecast cash outflows.
Ex: Lease payment for premises, annual rent payment,
electricity, gas, water and other bills, labour cost
payments and variable cost payments (cleaning).
➤ All firms should engage in cash flow forecasting to help
identify cash flow problems before it is too late.
3.7.4.CASH FLOW
FORECASTS
➤All cash flow forecasts have three basic
sections:
➤ Cash inflows: This section records the cash payments to the business (cash sales,
payments for credit sales and capital inflow).
➤ Cash outflow: This section records the cash payments made by the business (wages,
materials, rent and other costs).
➤ Net mothly cash flow and opening and closing balance: It shows the estimated
difference between montly cash inflows and outflows (net monthly cash flow), the cash
held by the business at the start of the month (opening cash balance) and cash held at the
end of the month becomes next month’s opening balance (closing cash balance).

ELEMENTS JANUARY FEBRUARY MARCH …

CASH INFLOWS

XXX € € € €

XXX € € € €

CASH OUTFLOWS

XXX € € € €

XXX € € € €

OPENING
BALANCE
NET CASH FLOW Net monthly cash Inflows - Outflows Inflows - Outflows Inflows - Outflows Inflows - Outflows
flow
Op.balance + Op.balance + Op.balance + Op.balance +
CLOSING
BALANCE Net cash Net cash Net cash Net cash
flow flow flow flow
3.7.4.CASH FLOW
FORECASTS
BENEFITS OF CASH FLOW FORECASTS LIMITATIONS OF CASH FLOW FORECASTS

Mistakes can be made in preparing the revenue

Plans can be put in place to provide additional and cost forecasts (inexperienced staff in most
finance in case we have periods of negative cases).
cash flow.
Unexpected costs increases can lead
A new business proposal will never progress to major inaccuracies in forecasts.
beyond the initial planning stage unless
investors and bankers have access to a cash Incorrect assumptions can be made in
flow forecast estimating the sales of the business (poor
market research)
➤ Causes of cash flow
problems:
➤ Lack of planning

➤ Poor credit control: customers’ accounts, credit terms, bad

debt (unpaid customers’ bills).
➤ Allowing customers too much credit
➤ Expanding too rapidly (overtrading: cash flow
➤ shortage) Unexpected events
3.7.5.THE RELATIONSHIP BETWEEN INVESTMENT, PROFIT
AND CASH FLOW
➤ Business investment means capital expenditure
(spending on projects, usually long term, requiring
equipment, materials and resources of all kinds). Some
investments are building a new factory, researching and
developing a new product, taking over another business, etc.
➤ Investment spending leads to a cash outflow in the first year
of the project although the cost of the project is not
recorded at the time of the cash expenditure. The
actual expense is recorded as annual depreciation (loss of
➤
value) over the useful life of the assets purchased.
Table 3.7.2.
3.7.6.STRATEGIES FOR DEALING WITH CASH
FLOW PROBLEMS
➤ Thereare threemain strategies that
businesses can adopt to deal with cash
flow problems:
➤ Reducing cash outflows (delay
payments to suppliers and creditors,
delay spending on capital equipment,
use leasing, cut overhead spending
that does not directly affect output
(promotion costs))
➤
Improving cash inflows (overdrafts,
short- term loans, increase cash sales
or reduce credit terms to customers,
sale of assets, sale and leaseback
➤
and debt factoring).
Sourcing additional finance
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