CASH FLOW FORECASTS Part 10

Starter What is a Cash flow? Why do we use them?

Lesson Objective To explain the purpose of a cash flow forecast. To be able to identify inflows and outflows. To draw up a simple cash flow forecast.

Cash flow forecasts A cash flow forecast is a prediction of the future flows of money in and out of the business for a specified period of time. A cash flow forecast shows, month by month, the money that it is anticipated will be coming into the business and the money that the business will be paying out. The working capital is the money available after the business has paid out all the money owing. Cash flow is the money coming into a business (the income or inflows) and the money going out of the business (the expenditure or outflows). For a business to profit, more money needs to be flowing in than out.

Inflows and outflows

Why do businesses forecast cash flow? decide whether to expand or reduce existing activities decide whether to produce new goods or services, invest in new resources or carry out new activities identify any potential deficits and allow the business to plan ahead for them identify any potential surpluses so that the business can use this money to their benefit. Cash flow forecasts can be used to: Producing a cash flow forecast allows a business to plan how much money the business will have at any given time. This information can then be used to make decisions about business activities.

How to construct a basic cash flow forecast A spreadsheet program is normally used for completing simple cash-flow forecasts. Here, the headings of the six columns are the first six months of the year. Cash flow forecasts are normally done on a monthly basis for either six or twelve months ahead. The first column shows the amount of money the business expects to receive during January. A total is calculated at the bottom of this column.

How to construct a basic cash flow forecast The next section shows the amount of money the business expects to spend – its outflows. A total is calculated for each month.

How to construct a basic cash flow forecast The final section shows the opening balance for the month – this is the same as the closing balance from the month before. The next row shows the net cash flow. This is the total inflows minus the total outflows, i.e. the amount of money it is predicted the business will make in that month. The final row is the closing balance. This is worked out by adding the net cash flow to the opening balance. What do you notice about the net cash flow predicted for February?

How to construct a basic cash flow forecast

Indicating a negative cash flow Positive cash flow is when the inflows are greater than the outflows. Negative cash flow occurs when the outflows are greater than the inflows. If any figure (net cash flow, opening balance, closing balance, etc.) is a negative number, then it is shown either with a minus sign or between brackets, e.g. (£8,500). The money it is predicted will be lost is called the deficit. The money it is predicted will be gained is called the surplus. Be careful not to use the words profit and loss – these describe actual figures rather than future predictions.

Complete a basic cash flow forecast

Simon’s new car Simon Harris wants to buy a new car to take to university in September. He has estimated that a good second hand car will cost him £2500. Simon’s dad has agreed to give him £1500 at the end of August as an early birthday present, to help him buy the car. At the start of March, Simon had £450 in his bank account. He earns £150 a month working with his uncle. Simon is going to try and cut down on his spending. He estimates that he will spend £30 a month on clothes, magazines and music, and £25 a month socialising with his friends.

Simon’s new car – a cash flow forecast

Simon’s new car The following information is what actually happened to Simon. Revisit the cash flow forecast on the next slide and decide whether Simon can still afford his car. Simon spent £40 shopping in May and August. He worked a few extra hours in June and earned £175. He spent £80 going to a music festival in April. He only earned £100 in March.

Simon’s new car – revised cash flow forecast

How does cash flow work? Ben Matthews is creating a cash flow forecast for his farm business, growing potatoes. He plants the potatoes in March. The potatoes are harvested in September. Ben then sells them to the wholesaler and receives payment. Between March and September he has to pay for fertilizers, diesel for the farm vehicles, etc. What cash flow problems might Ben face?

Consequences of negative cash flow Negative cash flow can lead to serious problems for a business: A lack of working capital, which could result in the business being unable to pay its bills. Staff may not be paid on time which can lead to de-motivation and conflict. Creditors may not be paid on time, which may lead to stricter terms of credit in the future, or even no credit at all. In extreme cases creditors may take a business to court to reclaim what they are owed. Suppliers can offer discounts for prompt payments and the business may not be able to take advantage of these.

Planning ahead Ideally, there will always be more money coming into a business than going out. However, income and expenses often occur at different times, particularly for seasonal businesses such as farmers. While some payments can be arranged to suit a business, many outgoings, e.g. salaries and tax, have to be paid on fixed dates. Cash flow forecasts allow businesses to identify when they are likely to have a negative cash flow. This allows them to take actions to avoid or deal with the situation, e.g. by pre-arranging an overdraft. What other solutions for managing or avoiding a deficit can you think of?

ICT and cash flow forecasts

True or false?

1.Give two reasons why businesses prepare cash flow forecasts. 2.Give two examples of inflows to a business. 3.Give two examples of outflows from a business. 4. Suggest two methods for avoiding negative cash flow. 5.Explain why spreadsheets are often used to prepare cash flow forecasts. Question time!

Glossary