Cash Flow Forecasting and Working Capital

Cash flow forecasting and working capital
The importance of cash and of cash-flow forecasting

If a firm doesn’t have any cash to pay its workers, suppliers, landlord and government, the business
could go into liquidation– selling everything it owns to pay its debts. The business needs to have an
adequate amount of cash to be able to pay for all its short-term payments.
Cash – is a liquid asset immediately available for the business to use and spend.
Problems for the business if it has too little cash

 Can’t pay employees and suppliers,
 Production of goods stops.
 Liquidation (business stops and sells assets to pay debts)
Cash flow – money going into and out of a business over a period of time
Examples of cash inflow include
 Sales of products and services.
 Money received from bank loans and sale of assets.
 Capital raised from selling shares
Examples of cash outflow
 Purchasing of stock/inventory.
 Buying assets such as buildings, machinery etc.
 Employee wages and salaries
Cash flow cycle

Cash is needed by the business for operation -> Products are produced -> Products sold -> Customers
pay cash to the business -> REPEAT
Cash flow is not the same as profit!

Profit is the surplus amount after total costs have been deducted from sales. It includes all income and
payments incurred in the year, whether already received or paid or not yet received or paid
respectfully. In a cash flow, only those elements paid by cash are considered.
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. It can
help tell the manager:
 how much cash is available for paying bills, purchasing fixed assets or repaying loans
 how much cash the bank will need to lend to the business to avoid insolvency (running out of liquid
cash)
 whether the business has too much cash that can be put to a profitable use in the business
Example of a cash flow forecast for the four months:
The opening cash/bank balance is the amount of cash held by the business at the start of the month
Net Cash Flow = Total Cash Inflow – Total Cash Outflow
The net cash flow is added to opening cash balance to find the closing cash/bank balance– the
amount of cash held by the business at the end of the month. Remember, the closing cash/bank balance
for one month is the opening cash/bank balance for the next month!
The figures in bracket denote a negative balance, i.e., a net cash outflow (outflows > inflows)
Uses of cash flow forecasts

Starting up a business - when setting up the business the manager needs to know how much
cash is required to set up the business. The cash flow forecast helps calculate the cash outflows
such as rent, purchase of assets, advertising etc.
Statement of cash flow forecast is required by bank managers when the business applies for
a loan. The bank manager will need to know how much to lend to the business for its
operations, when the loan is needed, for how long it is needed and when it can be repaid.
Managing cash flow– if the cash flow forecast gives a negative cash flow for a month(s), then
the business will need to plan ahead and apply for an overdraft so that the negative balance is
avoided (as cash come in and the inflow exceeds the outflow). If there is too much cash, the
business may decide to repay loans (so that interest payment in the future will be low) or pay
off creditors/suppliers (to maintain healthy relationship with suppliers).
Managing an existing business.
How cash flow problems might be overcome

When a negative cash flow is forecast (lack of cash) the following methods can be used to correct it:
 Increase bank loans: bank loans will inject more cash into the business, but the firm will have
to pay regular interest payments on the loans and it will eventually have to be repaid, causing
future cash outflows.
 Delay payment to suppliers: asking for more time to pay suppliers will help decrease cash
outflows in the short-run. However, suppliers could refuse to supply on credit and may reduce
discounts for late payment
 Ask debtors to pay more quickly: if debtors are asked to pay all the debts they have to the
firm quicker, the firm’s cash inflows would increase in the short-run. These debtors will include
credit customers, who can be asked to make cash sales as opposed to credit sales for purchases
(cash will have to be paid on the spot; credit will mean they can pay in the future, thus
becoming debtors). However, customers may move to other businesses that still offers them
time to pay
 Delay or cancel purchases of capital equipment: this will greatly help reduce cash outflows
in the short-run, but at the cost of the efficiency the firm loses out on not buying new
technology and still using old equipment.
In the long-term, to improve cash flow, the business will need to attract more investors, cut costs by
increasing efficiency, develop more products to attract customers and increase inflows.
Working capital
Working capital – Capital (money) available for a business to pay for day to day operations
Working capital = current assets – current liabilities
Businesses need sufficient working capital to

 Pay employee wages and salaries.
 Figure out if they are in a good financial position to purchase supplies that are currently on sale
(e.g. Suppliers may give discounts to customers that pay by cash not credit)
 Ensure they have enough cash for day to day operations.
 Pay debts

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Cash flow forecasting and working capital

The importance of cash and of cash-flow forecasting

Problems for the business if it has too little cash

Cash flow cycle

Cash flow is not the same as profit!

Cash Flow Forecasts

Uses of cash flow forecasts

How cash flow problems might be overcome

Businesses need sufficient working capital to

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