GCE PROFESSIONAL BUSINESS SERVICES CASH FLOW 1 Learning

GCE PROFESSIONAL BUSINESS SERVICES CASH FLOW 1

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 3

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. 4

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 5

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 6

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 Opening balance Add cash flows in Less cash flows out Closing balance Jan (£) 10 20 (50) (20) Feb (£) (20) 50 (50) (20) Mar (£) (20) 100 (40) 40 7

CASH FLOW FORECAST TYPICAL CASH FLOWS IN TYPICAL CASH FLOWS OUT • Cash receipts • Cash payments from customers • Online payments from customers • Trade Receivable receipts • Interest received • Tax refunds • Cash payments • Non-current assets eg vehicles • Trade payables • Purchases • Expenses • Tax payments • Drawings (sole traders) • Dividends (companies) 8

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 10

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 11

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 12

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