Forecasting of cash flows

On completing this chapter, you will be able to:  Understand the importance of cash to business.  Explain the difference between a firm’s cash flow and its profit.  Structure a cash flow forecast and understand the sources of information needed for this  Evaluate the problems of cash-flow forecasting.  Analyse the difference causes of cash-flow problems.  Evaluate different methods of solving cash-flow problems.

Cash flow -Cash flow is the movement of money in and out of the business, project or financial product. -In accounting, cash flow is the difference in amount of cash available at the beginning of a period (opening balance) and the amount at the end of that period. (closing balance). -Cash flow is positive if the closing balance is higher than the opening balance, otherwise the cash flow is negative. -Cash comes in from sales, loan proceeds, investments and the sale of assets and goes out to pay for operating and direct expenses, principal debt service and the purchase of the assets.

Importance of Cash flow Cash flow is of vital importance to the health of a business. One saying is: “revenue is vanity, cash flow is sanity, but cash is king”. What this means is that whilst it may look better to have large inflows of revenue from sales, the most important focus for a business is cash flow. Many businesses may continue to trade in the short- to medium- term even if they are making a loss. This is possible if they can, for example, delay paying creditors and/or have enough money to pay variable costs. However, no business can survive long without enough cash to meet its immediate needs.

Cash flow is vital for entrepreneurs because: -New start-ups are often offered much less time to pay suppliers than larger, well established firms. -Banks and other lenders may not believe the promises of new business owners as they have no trading history. They will expect payment at the agreed time. -Finance is often very tight at start-up so not planning accurately is of even more significance for new businesses.

Cash and profit-what’s the difference? -profit is how much money you have left after you get your revenue and pay your expenses. Cash flow is when you actually get and pay the cash. -Even if you’re profitable, you survive or fail based on whether you have cash to pay the bills. -And, even if you have a great cash flow, you cannot be profitable. -Lets look at the examples given in the text book

How to forecast cash flow? Forecasting cash flow means trying to estimate future cash inflows and cash outflows, usually on a month by month basis. Forecasting cash inflows -Owner’s capital injection -Bank loans -Customer’s cash purchases (sales forecast) -Debtors’ payments

Forecasting cash outflows Lease payment for premises Annual rent payment Electricity, water and telephone bills Labour cost payments Variable cost payments

The structure of cash-flow forecasts (txt book) sec 1: Cash inflows sec 2: Cash outflows sec 3: Net monthly cash flow and opening and closing balance What uses does this type of financial planning have? -seeing periods of negative cash flow, plans can be put in place to provide additional finance. -If negative cash flows appear to be too great, plans can be made for reducing those. (eg:no sales on credit ). -A new biz proposal will never progress beyond the initial planning stage unless investors and bankers have access to a cash flow forecast. -other assumptions…

Cash flow forecasting-what are the limitations? -Mistakes can be made in preparing the revenue and cost forecasts or they may be drawn by inexperience experiences or staff. -Unexpected cost increases. -Wrong assumptions. (poor market research)

The causes of cash-flow problems -Lack of planning. -Poor credit control. - Allowing customers too long to pay debts. -Expanding too early. -Unexpected events

Ways to improve cash flow - Increase cash inflows ( see table in txt book) - Reduce cash outflows (see table in txt book) - Managing working capital Debtors Creditors Inventory Cash