1. Managing Cash Flows Chapter 1 DENISE NICHOLSON denise_nicholson@gateshead.ac.uk

2. What we will cover in this chapter: Differences between accounting to establish profit or loss and accounting for cash Working capital What affects working capital How the cash cycle can be measured.

3. WHY IS CASH DIFFERENT FROM PROFIT Profitability is the amount by which income exceeds expenditure, and can be seen as the overall wealth of the business We often use cash based receipts and payments as a starting point then make adjustments such as accruals and prepayments, depreciation etc The increase in the business wealth is known as profit This is the accruals system of accounting.

4. Cont..... Cash receipts and payments are normally recorded in the business’s cash book Receipts and payments are expressions that relate just to cash items and do not incorporate any of the adjustments that are used to calculate income and expenditure when calculating profit We must be careful to understand the distinction between these two sets of terms.

5. THE IMPORTANCE OF CASH A business needs to plan, monitor and control cash Cash is as important as profit because; – Daily operations of a business depend on it – The survival of a business depends on it.

6. WORKING CAPITAL AND THE CASH CYCLE Working capital is part of the net resources of the business that is made up of current assets minus current liabilities The cash cycle involves the circulation of the elements of inventory (stock), receivables (debtors), cash and payables (creditors) The value of these elements will change on a daily basis.

7. Which of the following is not part of the working capital Receivables Non-current assets PayablesInventory

8. WORKING CAPITAL AND THE CASH CYCLE CashPayablesInventoryReceivables

9. CALCULATING THE CASH CYCLE The shorter the cash cycle, the fewer resources will be needed, as the business is making better use of its working capital Can be calculated in days, weeks or months Cash cycle = inventory days + receivable days – payable days.

10. CALCULATIONS Inventory (stock) Turnover Inventory days = inventory x 365 cost of sales

11. CALCULATIONS Receivables’ (Debtors’) Collection Period Receivable days = receivables x 365 credit sales

12. CALCULATIONS Payables’ (Creditors’) Payment Period Payable days =payables x 365 credit purchases

13. Example Statement of financial position Current Assets Inventory80000 Receivables93000 Cash17000 Current Liabilities Payables55000

14. Example Income Statement Sales500000 Less cost of sales Opening inventory120000 Purchases300000 Less closing inventory(80000) (340000) Gross Profit160000

15. Example Inventory days = 80000/340000 x 365 days 86 days Receivable Days = 93000/500000 x 365 days 68 days Payable days = 55000/300000 x 365 days 67 days Cash cycle = 86 + 68 – 67 = 87 days

16. Activity Handout Cash Operating Cycle (Working Capital) typed Question 1 and 2 from chapter task handout (BPP) Handout Cash Operating Cycle (BPP p6/7)

17. Discussion Company Survival – Cash Operating Cycle is Key Why should I be concerned with it – Example page 2 of handout Activity – Comparison Handout

18. Liquidity Ratios Current Ratio Current Assets Current Liabilities Acid Test Ratio (Quick Ratio) Current Assets less Inventory (Stock) Current Liabilities Handout + Activity

19. Overtrading Occurs when a business attempts to expand its level of trading and then has insufficient working capital and insufficient cash available to support that increased level of trading

20. Warning signs Rapid increasing sales levels Falling profit margins Inability to collect cash promptly Deterioration of cash balances

21. Over Capitalisation Over capitalisation is the opposite of overtrading. It involves having more resources tied up in working capital than is needed. Warning signs are; High levels of cash Payments being made to suppliers before they are due

22. Activity Question 3 from BBP Handout (given out earlier) Activity 5 page 7 – Kaplan textbook

23. THE IMPORTANCE OF CASH FLOW When you think about a business you ask – Is it profitable? Profit is not enough! – Needs enough cash in the bank or overdraft facility – To pay debts when they fall due (liquidity in previous lesson) A business must be profitable and also have access to cash.

24. CASH AND PROFIT - DIFFERENCES Accruals concept – Revenues from sales and cost of goods sold are accounted for in the period they are earned or incurred Accruals and Prepayments Non cash expenses – Some expense incurred will have no affect on the cash in a business e.g. Depreciation FRS 18 Kaplan p 9

25. CASH AND PROFIT Purchase of fixed assets – Cash used to acquire the asset, appears on the balance sheet – no effect on profit Sale of fixed assets – Cash proceeds from the sale, however, only the profit/loss on the sale will affect the profit of the business Receipts/payments not affecting profit – Examples include injections of capital, drawings, shares

26. CASH AND PROFIT Which of the following has the same impact on the cash and the profit? A.Purchase of a new computer for the business B.Accrual of an electricity account C.Payment of monthly wages D.Sale of a company car

27. CASH AND CREDIT TRANSACTIONS A cash transaction takes place with either coins, notes, cheque, credit or debit card. Money will be available in the business account as soon as deposits are made A credit transaction where receipt or payment is delayed due to agreed terms with either a customer or supplier, normally 30 or 60 days time

28. CASH AND CREDIT TRANSACTIONS In each of the following select the correct option A.A cheque made out for the payment of rent is a [cash transaction/credit transaction] B.Credit card sales of £800 is a [cash transaction/credit transaction] C.Good purchased for £250 with payment made on receipt of invoice is a [cash transaction/credit transaction] D.Goods and invoice delivered to a customer today for payment in 30 days is a [cash transaction/credit transaction]

29. ACCRAULS CONCEPT Has a major impact on differences between cash flow and profit Discuss Worked example page 10 – text book Discuss Worked example page 11 – text book

30. CALCULATING CASH FLOWS You will be required to: – Calculate actual cash received from receivables using open and closing receivables balances and sales revenue – Calculate actual cash paid to payables using open and closing payables balances and purchases – Calculate actual cash paid for expenses using accruals and/or prepayments to adjust expenses

31. TASK Income statement for 3 months ended March show sales of £125,000, purchases of £80,000 and operating expenses of £15,000 31 March1 January Debtors£10,000£14,000 Creditors£11,000£8,000 Accruals£2,000£3,000 Calculate the cash flows for: Sales£ Purchases£ Operating expenses£

32. TASK - ANSWERS Income statement for 3 months ended March show sales of £125,000, purchases of £80,000 and operating expenses of £15,000 31 March1 January Debtors£10,000£14,000 Creditors£11,000£8,000 Accruals£2,000£3,000 Calculate the cash flows for: Sales£125,000 + £14,000 - £10,000 = £129,000 Purchases£80,000 + £8,000 - £11,000 = £77,000 Operating expenses£15,000 + £3,000 - £2,000 = £16,000

33. TASKS Activity 6 p 14 (together) Activity 7 p 19 BPP Task 2.3

34. CAPITAL EXPENDITURE FIGURES From the balance sheet we can see fixed assets less accumulated depreciation From the profit and loss we can see the annual depreciation charge From this information we can calculate the amount of cash spent on fixed assets in the period

35. EXAMPLE Opening fixed assets of £100,000, closing balance of £120,000 and depreciation charge of £10,000 £ Opening balance100,000 Less depreciation charge(10,000) 90,000 Closing balance120,000 Cash expenditure30,000

36. Student Tasks Example p 15 Purchase and Sale of non- current assets Disposals