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CFS Explanation

Cash flow refers to the money coming into and going out of a business over time. It is distinct from profit in that profit calculations include non-cash items while cash flow only considers actual cash receipts and payments. Constructing and analyzing cash flow forecasts is important for businesses to plan cash needs, anticipate deficits or surpluses, and inform financial decision making. While forecasts provide benefits like improved planning, they also have limitations such as potential inaccuracies from changes in external factors.

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DELFIN, LORENA D.
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29 views

CFS Explanation

Cash flow refers to the money coming into and going out of a business over time. It is distinct from profit in that profit calculations include non-cash items while cash flow only considers actual cash receipts and payments. Constructing and analyzing cash flow forecasts is important for businesses to plan cash needs, anticipate deficits or surpluses, and inform financial decision making. While forecasts provide benefits like improved planning, they also have limitations such as potential inaccuracies from changes in external factors.

Uploaded by

DELFIN, LORENA D.
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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GCE PROFESSIONAL BUSINESS SERVICES

CASH FLOW

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Learning Outcomes
Students should be able to:
• define the term cash flow
• understand the distinction between cash flow and profit
• understand the importance of cash flow forecasting for financial decision
making
• construct and complete a cash flow forecast, including receipts (cash
inflows), payments (cash outflows) and opening and closing balances for a
business
• analyse a cash flow forecast
• analyse the benefits and limitations of cash flow forecasting for a business

2
CASH FLOW - Definition

• Is the money coming into and going out of a


business over a period of time. Money comes
in through sales, capital, finance and money
goes through purchases, wages and overheads

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CASH FLOW
Distinction between cash and profit
• Cash is all the money in the business, (eg coming in
through sales revenues or paid out through overheads)
• not all of this cash can be used in the calculation of profit,
for example purchasing a non current asset will cause a
reduction in cash, but will not impact on profit.
• The calculation of profit:
– also includes non-cash expenses (which are not therefore included in a
cash flow forecast) such as bad debts written off and/or depreciation.
– is subject to ‘accounting adjustments’ which mean that the profit/loss
for the financial period may not necessarily be the same amount as
the closing cash balance as at the end of the financial period.

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IMPORTANCE OF CASH FLOW

• Cash flow is important to a business in context


of decision making since a business:
– needs a supply of ready money
– needs to pay essential debts immediately
– Needs to maintain a good reputation with suppliers
– Needs to reduce finance costs by avoiding
overdrafts/loans
– Needs to plan ahead for the future

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IMPORTANCE OF CASH FLOW (Cont’d)

• Supports decisions taken in context of the


operational business plan
• Allows owner to plan business expenditure
• Facilitates spending decisions and reviews
• Highlights amount of debt finance that could
be repaid and prioritise related decisions
• Facilitates correct decision making in context of
resource allocation
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CASH FLOW FORECAST

• CONSTRUCTION OF CASH FLOW FORECAST:


• Normally comprised of following key elements:
– Time period, amount, cash flow in/out, opening/clos. balances
Sample layout:
• Month Jan (£) Feb (£) Mar (£)

• Opening balance 10 (20) (20)


• Add cash flows in 20 50 100
• Less cash flows out (50) (50) (40)
• Closing balance (20) (20) 40
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CASH FLOW FORECAST

TYPICAL CASH FLOWS IN TYPICAL CASH FLOWS OUT


• Cash receipts • Cash payments
• Cash payments from • Non-current assets eg
customers vehicles
• Online payments from • Trade payables
customers • Purchases
• Trade Receivable receipts • Expenses
• Interest received • Tax payments
• Tax refunds • Drawings (sole traders)
• Dividends (companies)

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PURPOSE OF A CASH FLOW FORECAST

• Enables business managers to make key decisions in


relation to setting business targets eg strategic
planning
• Shows management when the money is needed and
how much managers can make decisions to ensure
availability of funds
• Preparation of cash flow forecast should support
lending decisions when applying for a loan

9
ANALYSIS OF A CASH FLOW FORECAST
• Cash flows change for the following reasons:
– Lease instead of outright purchase of non-current
assets eg buildings, equipment
– Delaying the purchase of non-current assets eg vehicles
– Shortening the average trade receivables collection
period
– Reduce Inventory Levels thus reduce cash tied up in
this type of asset
– Negotiation with suppliers to extend trade payables
– Sale of assets, other sources of income stated

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CASH FLOW FORECAST - BENEFITS
• Facilitates improved planning and control of business
activities – eg payment dates for expenses are known
• Enables managers to forecast future cash flows more
accurately – eg deficits can be avoided by postponing
certain payments
• Allows managers to anticipate ‘peaks’ and ‘troughs’ in the
cash cycle and take corrective action – surpluses can be
re-invested to generate additional income
• Assists co-ordination between managers – eg agreement
of an investment/project start date

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CASH FLOW FORECAST - LIMITATIONS
• Cash flow estimates and may not be entirely accurate – a
cash deficit may occur if costs are underestimated
• Cash Flow Forecasts are subject to inaccuracies as the
data may change due to a number of external factors
which are beyond the control of business managers,
including: changes in economic conditions, changes in
interest rates, seasonal fluctuations and global events –
eg interest costs may increase by £10,000 causing a cash
deficit
• Forecasts only consider cash payments and receipts only –
ignores non-cash expenses which reduces profits
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Learning Check
Can you:
• define the term cash flow
• understand the distinction between cash flow and profit
• understand the importance of cash flow forecasting for financial decision
making
• construct and complete a cash flow forecast, including receipts (cash
inflows), payments (cash outflows) and opening and closing balances for a
business
• analyse a cash flow forecast
• analyse the benefits and limitations of cash flow forecasting for a business

13

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