BUSINESS STUDIES.

Cash Flow Forecasting and

Working Capital
 Why is cash important?

 If a firm doesn’t have any cash to pay its

workers, suppliers, landlord and government,
the business could go into liquidation– selling
everything it owns to pay its debts. The
business needs to have an adequate amount of
cash to be able to pay for all its short-term
payments.
 Cash Flow

 The cash flow of a businesses is its cash inflows and cash

outflows over a period of time.
 Cash inflows are the sums of money received by the
business over a period of time.
 E.g.:
 sales revenue from sale of products
 payment from debtors– debtors are customers who have
already purchased goods from the business but didn’t
pay for them at that time
 money borrowed from external sources, like loans
 the money from the sale of business assets
 investors putting more money into the business
 Cash outflows
 Cash outflows are the sums of money paid out
by the business over a period of time.
 Eg:
 purchasing goods and materials for cash
 paying wages, salaries and other expenses in cash
 purchasing fixed assets
 repaying loans (cash is going out of the business)
 by paying creditors of the business- creditors are
suppliers who supplied items to the business but
were not paid at the time of supply.
The cash flow cycle:
Cash flow is not the same as profit!
 Cash flow is not the same as profit! Profit is
the surplus amount after total costs have been
deducted from sales. It includes all income and
payments incurred in the year, whether
already received or paid or to not yet received
or paid respectfully. In a cash flow, only those
elements paid by cash are considered.
 Cash Flow Forecasts

 A cash flow forecast is an estimate of future cash

inflows and outflows of a business, usually on a month-
by-month basis. This then shows the expected cash
balance at the end of each month. It can help tell the
manager:
 how much cash is available for paying bills, purchasing
fixed assets or repaying loans
 how much cash the bank will need to lend to the
business to avoid insolvency (running out of liquid
cash)
 whether the business has too much cash that can be put
to a profitable use in the business
Example of a cash flow forecast for the four
months:
 The cash inflows are listed first and then the
cash outflows. The total inflows and outflows
have to be calculated after each section.
 The opening cash/bank balance is the amount
of cash held by the business at the start of the
month
Net Cash Flow = Total Cash Inflow – Total
Cash Outflow
 The net cash flow is added to opening cash
balance to find the closing cash/bank balance–
the amount of cash held by the business at the
end of the month. Remember, the closing
cash/bank balance for one month is the
opening cash/bank balance for the next month!
 The figures in bracket denote a negative
balance, i.e., a net cash outflow (outflows >
inflows)
 Uses of cash flow forecasts:
 when setting up the business the manager
needs to know how much cash is required to
set up the business. The cash flow forecast
helps calculate the cash outflows such as
rent, purchase of assets, advertising etc.
 A statement of cash flow forecast is required
by bank managers when the business
applies for a loan. The bank manager will
need to know how much to lend to the
business for its operations, when the loan is
needed, for how long it is needed and when
it can be repaid.
 Cont.
 Managing cash flow– if the cash flow forecast
gives a negative cash flow for a month(s), then
the business will need to plan ahead and apply
for an overdraft so that the negative balance is
avoided (as cash come in and the inflow
exceeds the outflow). If there is too much cash,
the business may decide to repay loans (so that
interest payment in the future will be low) or
pay off creditors/suppliers (to maintain
healthy relationship with suppliers).
How can cash flow problems be overcome?

 Increase bank loans: bank loans will inject

more cash into the business, but the firm will
have to pay regular interest payments on the
loans and it will eventually have to be repaid,
causing future cash outflows
 Delay payment to suppliers: asking for more
time to pay suppliers will help decrease cash
outflows in the short-run. However, suppliers
could refuse to supply on credit and may
reduce discounts for late payment
 Cont.
 Ask debtors to pay more quickly: if debtors are asked to
pay all the debts they have to the firm quicker, the firm’s
cash inflows would increase in the short-run. These debtors
will include credit customers, who can be asked to make
cash sales as opposed to credit sales for purchases (cash
will have to be paid on the spot, credit will mean they can
pay in the future, thus becoming debtors). However,
customers may move to other businesses that still offers
them time to pay
 Delay or cancel purchases of capital equipment: this will
greatly help reduce cash outflows in the short-run, but at
the cost of the efficiency the firm loses out on not buying
new technology and still using old equipment.
 Cont.
 In the long-term, to improve cash flow, the
business will need to attract more
investors, cut costs by increasing
efficiency, develop more products to attract
customers and increase inflows.
 Working Capital

 Working capital the capital required by the business to pay its

short-term day-to-day expenses. Working capital is all of the
liquid assets of the business– the assets that can be quickly
converted to cash to pay off the business’ debts. Working capital
can be in the form of:
 cash needed to pay expenses
 cash due from debtors – debtors/credit customers can be asked to
quickly pay off what they owe to the business in order for the
business to raise cash
 cash in the form of inventory –  Inventory of finished goods can be
quickly sold off to build cash inflows. Too much inventory results
in high costs, too low inventory may cause production to stop.
