GCE PROFESSIONAL BUSINESS SERVICES CASH FLOW

Learning Outcomes Students should be able to: define the term cash flow understand the distinction between cash flow and profit understand the importance of cash flow forecasting for financial decision making construct and complete a cash flow forecast, including receipts (cash inflows), payments (cash outflows) and opening and closing balances for a business analyse a cash flow forecast analyse the benefits and limitations of cash flow forecasting for a business

CASH FLOW - Definition Is the money coming into and going out of a business over a period of time. Money comes in through sales, capital, finance and money goes through purchases, wages and overheads

CASH FLOW Distinction between cash and profit Cash is all the money in the business, (eg coming in through sales revenues or paid out through overheads) not all of this cash can be used in the calculation of profit, for example purchasing a non current asset will cause a reduction in cash, but will not impact on profit. The calculation of profit: also includes non-cash expenses (which are not therefore included in a cash flow forecast) such as bad debts written off and/or depreciation. is subject to ‘accounting adjustments’ which mean that the profit/loss for the financial period may not necessarily be the same amount as the closing cash balance as at the end of the financial period.

IMPORTANCE OF CASH FLOW Cash flow is important to a business in context of decision making since a business: needs a supply of ready money needs to pay essential debts immediately Needs to maintain a good reputation with suppliers Needs to reduce finance costs by avoiding overdrafts/loans Needs to plan ahead for the future

IMPORTANCE OF CASH FLOW (Cont’d) Supports decisions taken in context of the operational business plan Allows owner to plan business expenditure Facilitates spending decisions and reviews Highlights amount of debt finance that could be repaid and prioritise related decisions Facilitates correct decision making in context of resource allocation

CASH FLOW FORECAST CONSTRUCTION OF CASH FLOW FORECAST: Normally comprised of following key elements: Time period, amount, cash flow in/out, opening/clos. balances Sample layout: Month Jan (£) Feb (£) Mar (£) Opening balance 10 (20) (20) Add cash flows in 20 50 100 Less cash flows out (50) (50) (40) Closing balance (20) (20) 40

CASH FLOW FORECAST Cash receipts Cash payments from customers TYPICAL CASH FLOWS IN TYPICAL CASH FLOWS OUT Cash receipts Cash payments from customers Online payments from customers Trade Receivable receipts Interest received Tax refunds Cash payments Non-current assets eg vehicles Trade payables Purchases Expenses Tax payments Drawings (sole traders) Dividends (companies)

PURPOSE OF A CASH FLOW FORECAST Enables business managers to make key decisions in relation to setting business targets eg strategic planning Shows management when the money is needed and how much managers can make decisions to ensure availability of funds Preparation of cash flow forecast should support lending decisions when applying for a loan

ANALYSIS OF A CASH FLOW FORECAST Cash flows change for the following reasons: Lease instead of outright purchase of non-current assets eg buildings, equipment Delaying the purchase of non-current assets eg vehicles Shortening the average trade receivables collection period Reduce Inventory Levels thus reduce cash tied up in this type of asset Negotiation with suppliers to extend trade payables Sale of assets, other sources of income stated

CASH FLOW FORECAST - BENEFITS Facilitates improved planning and control of business activities – eg payment dates for expenses are known Enables managers to forecast future cash flows more accurately – eg deficits can be avoided by postponing certain payments Allows managers to anticipate ‘peaks’ and ‘troughs’ in the cash cycle and take corrective action – surpluses can be re-invested to generate additional income Assists co-ordination between managers – eg agreement of an investment/project start date

CASH FLOW FORECAST - LIMITATIONS Cash flow estimates and may not be entirely accurate – a cash deficit may occur if costs are underestimated Cash Flow Forecasts are subject to inaccuracies as the data may change due to a number of external factors which are beyond the control of business managers, including: changes in economic conditions, changes in interest rates, seasonal fluctuations and global events – eg interest costs may increase by £10,000 causing a cash deficit Forecasts only consider cash payments and receipts only – ignores non-cash expenses which reduces profits

Learning Check Can you: define the term cash flow understand the distinction between cash flow and profit understand the importance of cash flow forecasting for financial decision making construct and complete a cash flow forecast, including receipts (cash inflows), payments (cash outflows) and opening and closing balances for a business analyse a cash flow forecast analyse the benefits and limitations of cash flow forecasting for a business