Cash Flow Forecasting and Working Capital
Cash is a liquid asset, it is immediately available for spending.
What is cash flow?
Cash flow is a business’s cash inflow and outflow over some time.
Potential problems of low cash to spend:
- being unable to pay workers, suppliers, landlords, government
- production of goods and services will stop – workers will not work for no pay and suppliers will not supply goods if they are not paid
- the business may be forced into ‘liquidation’ – selling up everything it owns to pay its debts
| Cash outflow– the sum of money spent by a business | Cash outflow– sum of money spent by a business |
| Payment received from sale of products.Payment from debtors.Finance received from external sources | Wages Paid to employeesPayment made to suppliers of raw materialRepayment of loans |
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.
Details a cash flow forecast can provide:
- how much cash is available for paying bills, repaying loans or buying fixed assets
- how much cash the bank might need to lend to the business to avoid insolvency
- whether the business is holding too much cash which could be put to a more profitable use.
Uses of cash flow forecasts
- Starting up a business because a cash flow forecast can help an entrepreneur plan how the business will operate, how much cash is needed, how much cash inflow should be expected, etc.
- Running an existing business efficiently as understanding the cash flow scenario can help a director to make better decisions in using existing financial resources and what is the optimum amount to be borrowed.
- Keeping the bank manager informed as a business should let the bank manager know the financial situation as a summary of cash inflows and outflows can act as credibility for a bank loan.
- Managing cash flow because analyzing cash inflows and outflows can help businesses make more efficient decisions involving a business’s financial resources.
Net cash flow is the difference (each month) between inflows and outflows.
The closing cash balance is the amount of cash held by the business at the end of each month. This then becomes the next month’s opening cash balance.
The opening cash balance is the amount of cash held by the business at the start of the month.
Solving cash flow problems in the short-term
| Method of overcoming cash flow problem | How it works | Limitations |
| Increasing bank loans | Bank loans will inject more cash into the business | Interest must be paid – this will reduce profitsThe loans will have to be repaid eventually – a cash outflow |
| Delaying payments to suppliers | Cash flows will decrease in the short term | Suppliers could refuse to supplySuppliers could offer lower discounts for late payments |
| Asking debtors to pay more quickly – or insisting on only ‘cash sales’ | Cash inflows will increase in the short term | Customers may purchase from another business that still offers them time to pay (trade credit) |
| Delay or cancel purchases of capital equipment | Cash outflows for purchase of equipment will decrease | The long-term efficiency of the business could decrease without up-to-date equipment |
Solving cash flow problems in the short-term
- Attracting new investors
- Increasing efficiency
- Developing new products to increase sales
Working Capital
Working capital is the capital available to a business in the short term to pay for day-to-day expenses.
Working capital = current assets – current liabilities
Working capital may be held in the following forms:
- Cash
- The value of a firm’s debtors
- Current value of inventories
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