27. Forecasting cash flows

Question 1

Define cashflow

Answer 1

The sum of cash payments to a business (inflows) minus the sum of cash payments (outflows)

Question 2

Define cash inflow

Answer 2

Payments in cash received by a business such as those from debtors

Question 3

Define cash outflow

Answer 3

Payments in cash made by a business such as those to suppliers and workers

Question 4

Define liquidation

Answer 4

When a firm ceases trading and its assets are sold for cash to pay suppliers and other creditors

Question 5

Define insolvent

Answer 5

When a business cannot meet its short term debts

Question 6

Difference between cash and profit

Answer 6

Cash is the money that the business has to pay its bills, or the bank when they demand payment. Cash is the money available for use at a certain moment in time. Cash can come from profit.
Profit is earned from running the business well. Profit is earned over a period of time

Question 7

The need to hold a suitable level of cash within a business, and the consequences of not doing so

Answer 7

If a business runs out of cash and cannot pay its suppliers or workers it is insolvent. The owners must raise extra finance or cease trading

Question 8

Define cash-flow forecast

Answer 8

Estimate of a firm’s future cash inflows and outflows

Question 9

Define net monthly cash flow

Answer 9

Estimated difference between monthly cash inflows and outflows

Question 10

Define opening cash balance

Answer 10

Cash held by the business at the start of the month

Question 11

Define closing cash balance

Answer 11

Cash held at the end of the month and becomes next month’s opening balance

Question 12

Uses of cash flow forecast

Answer 12

• Identify potential shortfalls in cash balances in advance
• Make sure that the business can afford to pay suppliers and employees.
• Spot problems with customer payments – preparing the forecast encourages the business to look at how quickly customers are paying their debts.
• As an important discipline of financial planning – the cash flow forecast is an important management process, similar to preparing business budgets.
• External stakeholders such as banks may require a regular forecast.

Question 13

Limitations of cash flow forecast

Answer 13

• Mistakes can be made in preparing the revenue and cost forecasts or they may be drawn up by inexperienced entrepreneurs or staff
• Unexpected cost increases can lead to major inaccuracy. Fluctuation in prices
• Wrong assumptions can be made in estimating the sales of the business, maybe because of poor market research

Question 14

Define credit control

Answer 14

Monitoring of debts to ensure that credit periods are not exceeded

Question 15

Define bad debt

Answer 15

Unpaid customers’ bills that are now very unlikely to ever be paid

Question 16

Define overtrading

Answer 16

Expanding, a business rapidly without obtaining all of the necessary finance so that a cash flow shortage develops

Question 17

Causes of cash flow problems

Answer 17

• Poor credit control: debtors will not be chased up for payment and potential debts will not be identified
• Allowing customers too long to pay debts: reducing short term cash inflows => cash flow problems
• Expanding too rapidly: has to pay for expansion before it receives cash from additional sales
• Unexpected events

Question 18

2 ways to improve cash flow

Answer 18

• Increase cash flows

- Reduce cash outflows

Question 19

How to reduce cash outflows?

Answer 19

• Delay payments to suppliers
• Delay spending on capital equipment
• Use leasing, not outright purchase, of capital equipment
• Cut overhead spending that does not directly affect output e.g. promotion costs

Question 20

Delay payments to suppliers

Answer 20

• Cash outflows will fall in the short term if bills are paid after
• Suppliers may reduce any discount offered with the purchase
• Suppliers can either demand cash on delivery or refuse to supply at all if they believe the risk of not being paid

Question 21

Delay spending on capital equipment

Answer 21

• The efficiency of the business may fall if outdated and inefficient equipment is not replaced
• Expansion becomes difficult

Question 22

Use leasing

Answer 22

• The asset is not owned by the business

- Leasing charges include an interest include an interest cost and add to annual overheads costs

Question 23

Cut overheads spending that does not directly affect output

Answer 23

• These costs will reduce production capacity and cash payments will be reduced
• Future demand may be reduced by failing to promote the product effectively

Question 24

How to increase cash inflows?

Answer 24

• Overdraft
• Short-term loan
• Sale of assets
• Sale and leaseback
• Reduce credit terms to customers
• Debt factoring

Question 25

Sale of assets

Answer 25

- Selling assets can quickly can result in a low price | - The assets might be needed later for expansion or as a collateral for future loans

Question 26

Sale and leaseback

Answer 26

- Assets can be sold, but the asset can be leased back from the new owner - The leasing costs add to annual overheads - There could be loss of potential profit if assets rise in price - Could've been used as a collateral for future loans

Question 27

Debt factoring

Answer 27

- Only about 90-95% of the debt will now be paid by the debt factoring company - this reduces profit - The customer has the debt collected by the finance company - this could suggest that the business is in trouble