Ch 30 Forecasting and Managing Cash Flow

The Structure of Cash flow Forecast:

• Cash inflows: This section records the cash payments to the business, including cash
sales, receipts for credit sales, and capital inflows.
• Cash outflows: This section records the cash payments made by the business, including
wages, materials, rent and other costs.
• Net cash flow and opening and closing balance: This shows the net cash flow for
the period and the cash balances at the start and end of the period (the opening cash
balance and the closing cash balance). If the closing balance is negative (shown by a
figure in brackets), then a bank overdraft will almost certainly be necessary to finance this.

Month 1 Month 2 Month 3

Cash Inflow

Owners capital injection x x x

Cash sales x x x

Trade receivables x x x

Total Cash inflow x x x

Cash Outflow

Lease x x x

Rent x x x

Trade payables x x x

Labour x x x

Other Cost x x x

Total Cash outflow x x x

Net Cash Flow x x x

Opening Balance x x x

Closing Balance x x x

THE BENEFITS OF CASH FLOW FORECASTS

●​ Identifying the timing of cash shortages and surpluses, A forecast can help to identify
in advance when a business might wish to borrow cash. At the bottom of the
statement the monthly closing balances are shown clearly. This will help businesses
to take precautions beforehand.
 ●​ Supporting application of finance: When trying to raise finance lenders often insist
that businesses support their application with documents showing business
performance, outlook and solvency.
●​ Enhancing the planning process: careful planning in business is crucial. It helps to
clarify aims and improve performance. Producing a cash flow forecast is a key part of
the planning process because it is a document concerned with the future.
●​ Monitoring cash flow, during and at the end of the financial year a business Should
make comparisons between the predicted figures in the cash flow forecast and those
that actually occurred.

THE LIMITATION OF CASH FLOW FORECAST

●​ Some of the financial information used in forecasts will be based on estimates and
these estimates are often inaccurate.
●​ Business activity is subject to external forces that are beyond the control of owners
and managers.
●​ A business uses resources in preparing cash flow forecasts. Business owners or
employees will spend time gathering the information and assembling the forecast.
●​ A cash flow forecast only focuses on one important business variable: cash.

Causes of Cash Flow Problems

1.​ Lack of Planning:Not planning well for future cash needs can lead to cash flow
problems. Proper cash flow forecasting helps predict issues so they can be dealt with
in advance.
2.​ Poor Credit Control:If a business doesn't manage customer payments well, it may
not receive money on time. This can cause delays in cash flow and lead to unpaid
debts.
3.​ Allowing Customers Too Much Time to Pay:Offering long payment terms to
customers can delay cash coming into the business. While it might attract customers,
it can create cash flow problems in the short term.
4.​ Expanding Too Quickly:Rapid business growth requires spending money on things
like wages and materials before getting paid for increased sales. This can lead to
cash shortages, even if the business is doing well.
5.​ Unexpected Events:Sudden increases in costs or unforeseen events, like
equipment breakdowns or competitors lowering prices, can cause cash flow issues
that weren't planned for.

Methods of Improving Cash Flow

1.​ Cut Unnecessary Expenses:Review and reduce non-essential costs to keep more
cash in the business. This might include renegotiating contracts or cutting down on
overheads. However Cutting costs might hurt employee morale or lower the quality
of your products or services, which could affect customer satisfaction.
2.​ Increase Sales or Prices:Boost cash flow by increasing sales volume or raising
prices. Offering promotions or finding new customers can also help generate more
revenue. However Raising prices could drive customers away, especially if they can
 find cheaper options elsewhere. Pushing too hard for more sales might also annoy
customers.
3.​ Sell Unused Assets:Liquidate any idle or unnecessary assets to generate quick
cash. This can help cover immediate cash flow needs. However Selling assets
quickly can result in a low price. The assets might be required at a later date for
Expansion. The assets could have been used as collateral for future loans.
4.​ Bank overdraft or short term loan:Use options like a business overdraft, short-term
loan, or invoice financing to bridge temporary cash flow gaps. However Loans or
overdrafts add interest costs, making them more expensive. Relying too much on
borrowing can lead to debt problems.
5.​ Improve Inventory Management:Reduce excess inventory to free up cash tied up
in stock. This ensures that cash is not unnecessarily invested in items that are slow
to sell. However Cutting down on inventory might lead to running out of stock,
causing missed sales and unhappy customers.

Managing Trade Receivables to Improve Cash Flow

1.​ Not Extending Credit or Asking for Quicker Payments:

○​ How it Works: Reduce or eliminate credit terms, or request faster payment
from customers.
○​ Possible Drawbacks:
■​ Customers may choose competitors who offer credit.
■​ It could remove a key part of the business's marketing strategy,
leading to potential sales loss.
2.​ Selling Trade Receivables to Debt Factors:
○​ How it Works: Sell outstanding debts to financial institutions to receive
immediate cash.
○​ Possible Drawbacks:
■​ The business won’t receive the full value of the debts, as debt factors
take a cut for their services.
3.​ Checking Creditworthiness of New Customers:
○​ How it Works: Require references from other traders, banks, or use a credit
enquiry agency before extending credit.
○​ Possible Drawbacks:
■​ Could slow down the sales process or deter some customers from
purchasing.
4.​ Offering Discounts for Prompt Payment:
○​ How it Works: Encourage customers to pay quickly by offering them a
discount.
○​ Possible Drawbacks:
■​ While cash is received sooner, the profit margin is reduced due to the
discount.

Additional Methods to Improve Cash Flow

1.​ Delay Capital Expenditure:

○​ How it Works: Postpone buying new equipment, vehicles, etc., to avoid
immediate cash outflows.
 ○​ Possible Drawbacks:
■​ The business may suffer from inefficiency if outdated equipment is not
replaced.
■​ Expansion may be hindered.
2.​ Use Leasing Instead of Outright Purchase of Equipment:
○​ How it Works: Lease capital equipment instead of buying it outright, which
avoids a large cash outlay.
○​ Possible Drawbacks:
■​ The business does not own the asset.
■​ Leasing includes interest costs, which add to annual overheads.
3.​ Cut Non-Essential Overhead Costs:
○​ How it Works: Reduce costs like promotion that do not directly impact
production capacity.
○​ Possible Drawbacks:
■​ Future demand may decline if products are not promoted effectively,
potentially leading to reduced sales.

Managing Trade Payables to Improve Cash Flow

1.​ Purchase More Supplies on Credit Instead of Cash:

○​ How it Works: Buy supplies on credit to delay cash outflows, improving
immediate cash flow.
○​ Possible Drawbacks:
■​ Suppliers might stop offering discounts for quick payments.
■​ Some suppliers may refuse to offer credit terms, especially if the
business has a weaker credit rating.
2.​ Extend the Payment Period for Suppliers:
○​ How it Works: Take longer to pay suppliers, freeing up cash for other uses in
the short term.
○​ Possible Drawbacks:
■​ Small suppliers may struggle with delayed payments, which could
strain relationships.
■​ Suppliers might be less willing to provide products or offer good
service if they consider the business to be a late payer.