1. Financial performance – cash flow
5 Decision making to improve financial performance
Do you agree with these quotes?
“Sales for vanity, profit for sanity but cash is king”
“Profitable businesses can still go under if they run out of cash at a critical moment. Forecasting is the most focused method of avoiding that obstacle.”
Peter Jones  
Financial performance – cash flow
AQA Business

2. 5.2.2 Financial performance – cash flow
In this topic you will learn about
Analysing financial performance
How to construct and analyse cash flow forecasts
How to analyse timings of cash inflows and outflows
The use of data for financial decision making and planning
Making financial decisions
Methods of improving cash flow
Difficulties improving cash flow

3. The nature of cash flow Cash flows into AND out of a business
Cash sales
Payments from debtors
Owners’ capital invested
Sale of assets
Bank loan
Purchasing stock
Paying wages
Paying debts – bank loans, creditors
Purchasing assets
Cash flow is interested in the balance between these cash inflows and cash outflows in terms if their relative size and timings.

4. The nature of cash flow
Cash flow is important to a business as it needs to ensure a positive cash balance in order to be able to meet day to day expenses
A cash flow forecast is a forward looking statement that tries to predict cash inflows and outflows in the future
Cash flow forecasts are an important part of a business plan
A cash flow statement is a backward looking statement that shows what happened to cash inflows and outflows
Cash flow statements are normally presented as a part of a business’ accounts
A potentially profitable business may fail because it has cash flow problems
Before looking at this link try to list up to 11 common reasons why small businesses fail. At which number are you going to put running out of cash?
11 common reasons small businesses fail

5. How to construct a cash flow forecast
Forecast cash inflows
Owner’s investment or other source of finance
Cash sales estimated from sales forecast
may be over or under estimated
to some extent depends upon the scale of research
More difficult for new businesses
What is expertise of entrepreneur?
How have estimates been calculated?
Is it a new product or service?
How might competitors react?
Debtor payments estimated from sales forecast
Determined by credit terms offered to customers
Will debts be paid on time?
How good is firm’s credit control?

6. How to construct a cash flow forecast
Forecast cash outflows
Payment of fixed costs
These should be easy to estimate on a month by month basis
Time delay between estimates and signing contracts can cause inaccuracies
Payment of variable costs
If sales are difficult to forecast so are the costs associated with meeting demand
Made more difficult if suppliers are free to change the prices charged
Unforeseen expenses
One off payments that were not expected or expenses that have not been planned for
Payment terms
What if a supplier changes terms and wants payment sooner or a lender demands their money back
Unforeseen expenses can have a major impact on cash flow!
BP to pay £12bn for Gulf oil spill

7. How to construct a cash flow forecast
Cash inflows shows:
cash in from sales
cash sales appear in the month of sale
credit sales (receivables)appear in month of cash receipt
cash from other sources e.g. loan, investment
Cash outflows shows:
cash out for purchases and payments
Cash payments appear in month of purchase
Credit payments (payables) appear in month of cash outflow
E.g. phone usage – line rental paid each month, call charges every 3 months
Write a definition of receivables and payables.

8. How to construct a cash flow forecast
Net cash flow
The net result of cash inflows and cash outflows each month
Net cash flow = cash inflows – cash outflows
Opening balance
How much the business has at the start of each month
For a new business in month 1 this will be 0
The closing balance for one month becomes the opening balance for the next
Closing balance
How much the business has at the end of each month
Calculated as:
Opening balance + net cash flow

9. How to construct a cash flow forecast
Jan
Feb
Mar
Apr
Cash inflows
Owner’s capital
5000
Cash sales
1600
2000
2500
Credit sales
400
500
Total inflows
6600
2400
3000
Cash outflows
Van lease
700
Materials
2800
800
1000
Wages
Other expenses
450
Total outflows
4950
2950
3150
Net cash flow
1650
(550)
(150) 50
Opening balance
1100
950
Closing balance

10. The use of cash flow forecasts for financial decision making and planning
To identify the timing and significance of any potential shortfalls
To identify possible corrective action
To help secure finance from potential investors or the bank
To give confidence about short term survival
To provide a guide against which to measure actual cash flow

11. Factors affecting cash flow
Transaction types
Sales
cash v. credit
Purchases
Payment terms
Timings of cash flows
Seasonal sales
e.g. strawberry farm
Timings of payments in and out
e.g. package holiday company
Nature of business
Start-up capital and costs
Time taken from input to output
Stock holdings

12. Timings of cash inflows and outflows
If cash inflows are slow this may cause cash flow problems
A firm may try to speed up cash inflows
This may include offering a discount for early payment or penalties for late payments
Businesses may need to chase customers for payment i.e. credit control
When a business is owed money from customers these are referred to as receivables
The business is still to receive the payment
Why might a business be willing to offer a customer long payment terms?

13. Timings of cash inflows and outflows
Cash outflows
If cash outflows are too quick this may cause cash flow problems
A firm may try to slow down cash outflows
This may include negotiating longer payment terms from suppliers
When a business owes money to suppliers these are referred to as payables
The business is still to make the payment
What are the potential disadvantages to a business of asking for a longer period to pay?
Tesco accused of delaying payments to suppliers
What are the costs and benefits to Tesco of delaying payments to suppliers?
What is the likely consequence of this to their suppliers?

14. Cash Flow Problems
Businesses need to have sufficient cash to meet day to day finances
Buying stock
Paying wages
Utility bills
Insufficient liquid cash funds may mean an inability to meet short term debts
Bank overdraft
Payables (trade creditors)
Limited cash may result in missed opportunities
A key consideration should be whether the cash flow problem is short term or long term
A firm may be able to survive short term cash flow problems
Long term cash flow problems may be insurmountable

15. Causes of cash flow problems
Credit sales
Long payment terms
Poor credit control
Overtrading
Additional overhead and day to day expenses
Increased capital expenditure
Internal management
Stock control
Relationship with suppliers
Poor or inaccurate planning
Seasonality
Unexpected events
What were the causes of the cash flow problems at Newport?
Could Newport have done anything to avoid these problems?
Newport postponements causing cash flow problems - Boddy

16. Improving Cash Flow Increasing the volume of the inflow of cash
Speeding up the timing of the inflow of cash
Inflows
Capital invested
Loans
Cash sales
Debtor payments
Reducing the volume of the outflow of cash
Slowing down the timing of the outflow of cash
Outflows
Loan repayments
Day to day running expenses
Interest payments

17. Improving Cash Flow - Inflows
Using financial institutions i.e. banks
Overdraft – an arrangement with the bank allowing the business to withdraw money above the amount available
Provides some financial peace of mind
Backed by a cash flow forecast to show ability to repay
Allows flexibility
Incurs interest and possible arrangement fee
Can be ordered to repay immediately
Short-term loan – an arrangement with a bank to lend money for a set period of time
Pre agreed repayment terms
Incorporated into budget and cash flow
Interest rate may be lower than an overdraft
Interest is paid on the total value of the loan
May need to be backed by collateral
Biz Link
Overdrafts
An overdraft is a borrowing facility attached to your bank account, set at an agreed limit. It can be drawn upon at any time and is ideal for your day-to-day expenses, particularly to see you through cashflow problems.
Loans
A loan is an amount of money borrowed for a set period within an agreed repayment schedule. The repayment amount will depend on the size and duration of the loan and the rate of interest.

18. Improving Cash Flow - Inflows
Factoring
Debt factoring – the process of selling a business’ debts i.e. the money owed to it, to a factor house at a reduced amount in order to receive immediate payment
Immediate payment of debt
Reduced risk of non payment (bad debt)
Factor house takes a % as their profit
May alter customer’s image of business
Factoring is a service offered by banks. Read what RBS says about factoring.

19. Improving Cash Flow - Inflows
Sale of assets
Sale of assets – turning an obsolete asset into cash
Potentially quick cash injection
Asset must be no longer needed
Loss of future use or value of asset
Possible low value received
One off action
Sale and leaseback – turning an asset into cash whilst still being able to use it through a lease agreement
Quick cash inflow in the short term
Reduced value of business’ assets
Larger cash outflow in the long term
Assets are items owned by a business e.g. vehicles and machinery.

20. Improving Cash Flow - Inflows
Cash payments from customers
Reducing credit terms – credit terms refers to the amount of time a customer is given to pay for their goods and services
Some businesses offer customers a discount for immediate or quick payment
Quick cash inflow
Reduced risk of bad debt
May need to offer a discount
May lose customers
Credit control – the process of chasing payments from debtors (people who have bought from you on credit)
Brings cash into the business
Full amount received
May alienate customers
Administratively demanding
Should businesses enrol the help of experts in credit control?

21. Improving Cash Flow - Outflows
Delaying payment to suppliers
Negotiating longer payment terms
May incur penalties
Need to maintain positive relationship
Stock management
Reducing money tied up in stock
Need reliable stock deliveries
Reduce overhead spending
Cut unnecessary expenditure
Should not have negative impact on productivity
Consider any knock on effect on sales

22. Activity – Dave’s Direct Deliveries
Dave started his courier business 3D Ltd 5 years ago. It currently operates with a fleet of 8 trucks and 2 bikes. Over the past year however things have got tough; rising fuel prices, increased road tax and falling customer numbers have meant he has had to reduce his drivers from 8 to 5, all of whom are paid on a weekly basis.
Dave already has a bank loan for £50 000, the repayment on which has also gone up recently due to a rise in interest rates. Last month two of his regular customers cancelled their contracts, one of whom still owes him £ Both explained that they were moving to cheaper competitors who offered 45 day payment terms compared to Dave’s 30 days. Dave’s wife Doris helps out on a part time basis in the office where she answers the phone, sends invoices and keeps the financial records of payments and expenditure.
Dave is worried, his bank balance is nearly zero and if things don’t improve in the next 3 months he is anxious he will have serious cash flow problems and not be able to meet his day to day running costs.
Identify the possible steps Dave could take to help solve his cash flow problem.
For each step identify an argument for and against taking that step.
Recommend 3 proposals to Dave. You should prioritise and justify your proposed solutions.

23. Difficulties improving cash flow
Damage to the firm’s reputation
Potential loss of customers if payment terms affect competiveness
Administrative costs and time
Loss of discounts or need to offer discounts
May affect profitability e.g. only receive part of debt or more expensive to lease assets in the longer run

24. In pairs Method of improving cash flow
Potential difficulties of improving cash flow
Overdraft
Short term bank loan
Factoring
Sale of assets
Sale and leaseback
Cash payments from customers
Credit control
Delay payment to suppliers
Stock management
Reduce overhead spending

25. 1.1 Understanding the nature and purpose of business
In this topic you have learnt about
Analysing financial performance
How to construct and analyse cash flow forecasts
How to analyse timings of cash inflows and outflows
The use of data for financial decision making and planning
Making financial decisions
Methods of improving cash flow
Difficulties improving cash flow