Cash Flow

Cash Balances and Flows BUSS2 Focus Financial management Measuring performance Taking action to improve cash flow Budget Variances Profit Margins Cash Balances and Flows

Why Does Cash Matter?

Profit is a matter of Opinion! Thought for the Day (1) Profit is a matter of Opinion!

…continued Cash is a matter of Fact!

Revenue is Vanity Margin is Sanity Cash is King Thought for the Day (2) Revenue is Vanity Margin is Sanity Cash is King

An Important Distinction Two Kinds of Cash Flow in Business Trading Flows Financing Flows Cash sales & debtors Suppliers & payroll Stocks Buying fixed assets Leasing / hiring Overheads Tax Bank interest Bank loans (in & out) Shares – investment & dividends One-off asset deals

Trading Flows Right at the heart of managing a business Close link to business profitability Dictated by Industry norms (e.g. payment terms) Plenty of scope for active cash flow management

Financing Flows Determined by choices made about sources of finance Business is often at the mercy of outsiders – if it has debt Much less scope for active management

What Really Matters in Cash Flow Profitability – no hiding place Customers – the problem of late payment Suppliers – trading terms & relationships Stocks – not too little, not too much Financial structure Needs to be appropriate Match the asset to the right finance

Specification Red Herring Factoring Typically selling to other businesses Typical turnover £250k- £5m High cost: 5-10% loss of gross margin Factoring company collects debts Just 18,000 businesses use it in the UK: out of 4.5 million Invoice financing is much bigger

Profit and Cash Flow Be careful! Ways to Improve Cash Flow… “Care needs to be taken here – the aim is to improve the cash position of the business, not sales revenue or profits” Hodder AQA Business Textbook (2008)

Why Businesses Run Out of Cash Lack of profit (viability of business) Excess illiquid assets (too much working capital & production capacity) Too much growth (overtrading)

Cash Flow Clue-DOH!

Your Task Answer questions to obtain clues Examine the evidence Decide the three main reasons why Peston Plastics went bust

Five questions are in the sealed enveloped

Clues You can choose up to five pieces of evidence – one for each question answered correctly

Your choices (max 5) 1 2 3 4 5 6 7 Balance sheet at 30 September 2008 Exhibit Contains 1 Balance sheet at 30 September 2008 2 Profit & Loss Accounts for 2007 & 2008 (9 months) 3 Cash Flow Forecast for 2008 (7 months actual) 4 Memo from Ray Bodger (Finance Director) 5 Financial ratio analysis for Peston Plastics 6 Newspaper clippings for Peston Plastics 7 Comparison with key competitors

A C B D Q1 Short-term cash flow can be improved by Extending the period of trade credit A C Increasing overheads Increasing the value of finished stocks B D Repaying a bank loan

Q2 Which of the following is a possible symptom of "overtrading"? A significant fall in liquidity ratios A C A slowdown in turnover An increase in stock turnover B D A decrease in time taken to pay suppliers

Q3 Which one of these events might lead to a cash flow problem? Major supplier expands into China Govt cuts Corporation Tax rate A C Cost savings achieved on a large contract Customers ask for longer credit B D

Q4 Which of these defines the net working capital of a business? Trade debtors less trade creditors Cash balances less bank overdraft A C Current assets less current liabilities Fixed assets less depreciation B D

A C B D Q5 Cash flow could be improved by… Decreasing stock turnover Better credit control over trade debtors A C Reducing the gross profit margin B D Accelerating capital projects

Evidence Gathering Cash Flow Clue-DOH! A: Low profits Possible Causes of the Cash Flow Problem Yes / No Evidence A: Low profits B: Management of trade debtors C: Management of stocks D: Management of creditors E: Overtrading F: Seasonal demand G: Unforeseen change H: Over-investment in fixed assets I: Bad luck J: Credit crunch

Your Choice of the Three Reasons Example Only Reason 1 Reason 2 Reason 3 H D C

Your Choice of the Three Reasons

Does Your View Agree with the Receivers? STRICTLY CONFIDENTIAL Find Grabit & Sell Results of the investigation into the financial affairs of PESTON PLASTICS LIMITED Company Registration: 0856565845 IN RECEIVERSHIP

Exhibit 1 - Balance Sheet 2007 2008 £'m Dec Sept FIXED ASSETS Tangible fixed assets 68 95 CURRENT ASSETS Trade debtors 48 55 Stocks 7 10 Cash balances 15 CURRENT LIABILITIES Trade creditors 40 45 Bank overdraft 17 NET CURRENT ASSETS 30 3 Long-term liabilities 25 NET ASSETS 98 73 CAPITAL AND RESERVES Share capital 2 Profit and loss 96 71

Exhibit 2 - Profit and Loss Account 2006 2007 2008 £'m Actual Forecast Sales 190 175 150 Cost of Sales 72 75 Gross Profit 118 100 78 Wages & salaries 48 45 40 Other costs 47 43 39 Operating Profit 23 12 -1 Bank interest payable -6 -8 -10 Profit before tax 17 4 -11

Exhibit 3: Cash Flow Forecast - 2008 Jan Feb Mar Apr May Jun Jul Aug Sep £'m Actual Forecast Sales 8 10 13 15 Payments for stocks 3 5 6 7 Wages & salaries 4 Other costs 2 Payment for fixed assets 1 Bank loan repayment Bank interest Net cash flow -6 -13 -7 -2 Opening balance 9 -4 -10 -17 -15 -16 Closing balance

Exhibit 7 - Competitor Profiles Peston Plastics Declan Extrusions Evan Industrial Plastics JMR Plastic Extrusions Financial ratios Gross Profit Margin 52% 57% 56% 61% Operating Profit Margin -1% 8% 7% 9% Current Ratio 1.0 1.7 1.9 Quick Ratio 0.9 1.5 Stock turnover 7 9 11 Debtor days 112 100 94 81 Financial Summary (amounts in £m) Market share 1.2% 1.6% 2.0% 2.5% Sales 150 195 254 315 Operating Profit -1 15 17 29 Fixed Assets 95 59 102 120 Stocks 10 12 Trade debtors 55 53 65 70 Cash balances -17 19 6 45