Cash flow forecasts
This is a specific form of budgeting which involves calculating when money will come into the business and when it goes out. This is a very common exam topic! The idea is very simple, but they tie all the information up in the text of the question to make it complicated.
Why is it important?
• We can see when we will be short of cash, this means that action can be taken in time so there is no crisis. If we don’t have any money we can’t pay wages, or other bills. Would you work if you weren’t getting paid? It is no use telling workers that they will get paid in a few moths time.
• We can see when we have loads of cash. This can be just as big a problem. If the money is sat around doing nothing then it is waste. If we know this money is going to be there, then we can plan to do something with the cash.
• Support an application for finance. If we go to a bank asking for a loan, then they want to know we can pay them back. The cash flow forecast can show them that.
• Planning is always good.
Cash is not the same as profit
So don’t say profit when you mean cash surplus!
Why aren’t they the same?
1. Profit is made when the goods are sold, cash may not be received for weeks or even months later.
2. Depreciation, as we will see latter, affects profit, but has nothing to do with cash.
How do we solve a cash flow problem?
1. Get some sort of loan to get us through the problem time.
2. Chase up payment from creditors. This may have implications for the business in the long run.
Customers may go elsewhere if they are not getting sufficient credit.
3. Delay payments to creditors. Again, we may find it difficult to get credit in the future if we get a reputation as a late payer.
4. Sell assets. We do, of course, loose the use of the assets once someone else owns them. This may also be difficult to do quickly.
5. Put projects/expenditure on hold. This has obvious drawbacks for the firm.
6. Reducing the amount of stock we hold. If we have less stuff in stock, then we will have less to pay out.
This money can then be spent elsewhere. However, we might run out of stock, and loose customers that way.
7. Instead of buying equipment, and spending loads at once we could lease it, and so spend a little every month (See drawbacks of leasing), or we could buy it but arrange to pay in installments.
In general, it is necessary to explain the possible solution and any drawbacks. This is a good opportunity to show you can evaluate information. You must then make a decision depending on what is right for that particular firm. How will you know? It will tell you in case study information at the start of the question.
The bestselling guide to producing a cash flow forecast.
It is fairly straight forward. You just have to remember two things throughout. ‘When did the money come in?” and “When did it go out?”
A cash flow forecast is broken down into three main sections, inflows of money, outflows, and balances.
Inflows show (as you can guess) money coming into a business. Mainly sales, but it could be an injection of capital too. One of the main ways of making this complicated is to have sales split up into cash and credit sales. It is when the money comes in that is important, and not when the goods are sold. You will need two rows for sales to take this into account. These are then totaled and given the heading ‘total inflows’.
Outflows are (as you must have guessed by now) the money going out! Each item needs its own row. Things to watch out for are bills (like electricity) that are paid quarterly. This means every three months not every four; there are often one off items to be included here as well. These are added up and given the heading ‘total outflows’.
Balances show the overall position for the company. There are three entries here. The first is ‘net cash flow’, which is just total inflow minus total outflow. Next is ‘Opening balance’. This is the closing balance from last month. If it is a new business it will be 0. Finally we have ‘closing balance’. This shows how much money is in the firm’s bank account at the end of the month. It is the opening balance plus the net cash flow.
Step 1 Set up your table with months across the top looking down and a blank column on the left so you can add in a description of where the money is going/come from.
Step 2 Money in
Under this heading you want (probably) 3 subheadings.
“Cash sales” This is easy the money comes in the month the goods were sold
“Credit sales” These are a little more tricky. There will usually be some form of credit offered for a certain % of the firm’s sales. That money will not appear until a month or two later. Yes, I know we have sold them already, but it is when the money comes in that is important.
In this example I have given two month’s credit
“Capital” It is usual in exam questions for firms to receive a loan or need some other form of capital injection. This is a one-off item the rest of the row should be blank. So, if they receive a 400 loan in April it will look like this…
Step 3 Total Cash inflows
Add up the amount of money you have received in total for this month.
Step 4 Outflows
Under the heading Money out. It is now time to do the same with money going out. Again, there will probably be something (purchases usually) that is done on credit. So we will not pay for them until one month after we got and used them.
Step 7 Opening and closing balance
We now need to look at the cumulative picture. So we add the net cash flow to the opening balance (This is the money we had left over from last month). The closing balance of one month is the opening balance of the next.
Step 8 Finishing off the question
There will almost certainly be some negative closing balances (If there aren’t then do a quick double check of your working to make sure.)! The next question is what should you do about them?