CASH FLOW PLANNING

UNIT 8

THIS UNIT WILL EXPLAIN

• THE IMPORTANCE OF CASH FLOW TO BUSINESS OPERATIONS• HOW FIRMS CAN RUN SHORT OF CASH AND THE LIKELY

CONSEQUENCES OF THIS• HOW A CASH FLOW FORECAST IS CONSTRUCTED

WHAT IS MEANT BY CASH FLOW• CASH IS A LIQUID ASSET. THIS MEANS THAT IT IS

IMMEDIATELY AVAILABLE TO BE SPENT ON GOODS AND SERVICES ANY TIME. • MANY BUSINESS EXPERIENCE CASH FLOW PROBLEMS,

MEANING THAT THEY DO NOT HAVE ENOUGH CASH TO DO WHAT THEY WANT TO DO. CASH FLOW MEANS "THE FLOW OF MONEY IN AND OUT OF A BUSINESS".• THESE ARE WAYS CASH FLOW CAN OCCUR:

WHAT IS MEANT BY CASH FLOWTHESE ARE THE WAYS CASH FLOW CAN

OCCUR:• CASH INFLOWS:

• SALE OF GOODS FOR CASH.• PAYMENT FROM DEBTORS.• BORROWING FROM A SOURCE

(BUT WILL INEVITABLY LEAD TO CASH OUTFLOW IN THE FUTURE).• SALE OF UNWANTED ASSETS.• INVESTMENT FROM INVESTORS:

SHAREHOLDERS AND OWNERS

• CASH OUTFLOWS:

• PURCHASING GOODS FOR CASH.• PAYMENT OF WAGES,

SALARIES AND OTHERS IN CASH.• PURCHASING FIXED ASSE

TS.• REPAYING LOANS.• REPAYING CREDITORS.

WHAT IS MEANT BY CASH FLOW

• ACTIVITY 8.1: CASE STUDY TASK.

Transaction Cash Inflow Cash OutflowPurchase of new computer for cash

X

Sale of goods to customers – no credit given

X

Interest paid on a bank loan

X

Wages paid to staff XDebtors pay their bills XAdditional shares are sold to shareholders

X

Creditors are paid XBank overdraft is paid off

X

CASH FLOW CYCLEA CASH FLOW CYCLE SHOWS THE STAGES BETWEEN PAYING OUT CASH FOR LABOR, MATERIALS, ETC. AND RECEIVING CASH FROM THE SALE OF GOODS.

1.Cash need to pay for

2.materials, wages, rent,etc

3.Goods produced

4Goods sold

5.Cash payment

received for goods sold

CASH FLOW CYCLE• THE LONGER IT TAKES FOR CASH TO GET BACK TO THE

BUSINESS, THE MORE THE BUSINESS WILL NEED WORKING CAPITAL AND CASH.• THIS CYCLE ALSO HELPS US UNDERSTAND

THE IMPORTANCE OF CASH FLOW PLANNING. • THIS IS WHAT HAPPENS WHEN A COMPANY IS SHORT ON CASH:

CASH FLOW CYCLE• NOT ENOUGH TO PAY FOR MATERIALS -> OUTPUT AND SALES WILL FALL.• THE COMPANY WILL WANT TO INSIST CUSTOMERS ON PAYING IN CASH,

BUT THEY MIGHT LOSE THEM TO COMPETITORS WHO LET THEM PAY IN CREDIT.• THERE COULD BE A LIQUIDITY CRISIS WHEN IT DOES NOT HAVE

ENOUGH CASH TO PAY FOR OVERHEADS (BILLS, RENT, ETC.) AND THE BUSINESS MIGHT BE FORCED TO CLOSE DOWN BY ITS CREDITORS.• MANAGERS NEED TO PLAN THEIR CASH FLOW SO THAT THEY DO NOT END

UP IN THESE POSITIONS. 

WHAT CASH FLOW IS NOT!

• CASH FLOW IS NOT THE SAME AS PROFIT.

• WHAT WAS THE GROSS PROFIT?• SALES REVENUE – COST OF GOODS SOLD = $25,000

Goods sold to Customers

$40,000 50% cash,50% one month credit

Costs of goods sold

$15,000 Paid for in cash

WHAT CASH FLOW IS NOT!

• ASSUMING THE BUSINESS STARTED THE MONTH WITH NO CASH, HOW MUCH CASH DID IT HAVE AT THE END OF THE MONTH.• CASH INFLOW – CASH OUTFLOW• $20,000 (CASH SALES) - $15,000 = $5,000

Goods sold to Customers

$40,000 50% cash,50% one month credit

Costs of goods sold

$15,000 Paid for in cash

CASH FLOW PROBLEMS• HAVING A POSITIVE CASH FLOW IS VITAL FOR THE

SURVIVAL OF A BUSINESS, SINCE WITHOUT THE ABILITY TO PAY WORKERS AND SUPPLIERS THEN THE BUSINESS WILL SOON HAVE TO CEASE TRADING.• A PROFITABLE BUSINESS RUNNING OUT OF CASH =

INSOLVENCY

• THIS POTENTIAL PROBLEM IS COMPOUNDED BY THE FACT THAT BUSINESSES OFTEN HAVE TO PAY MANY EXPENSES SEVERAL WEEKS OR EVEN MONTHS BEFORE ANY CASH ACTUALLY FLOWS INTO THE BUSINESS.

CASH FLOW PROBLEMS• THE MAJOR CAUSES OF CASH FLOW CRISES FOR A

BUSINESS ARE:

• OVERTRADING -WHERE THE BUSINESS ATTEMPTS TO EXPAND TOO RAPIDLY, WITHOUT A SUFFICIENT FINANCIAL BASE.• HAVING TOO MUCH MONEY INVESTED IN STOCKS.

• ALLOWING TOO MUCH CREDIT TO THEIR CUSTOMERS.

• UNEXPECTED CHANGES IN DEMAND FOR THEIR PRODUCTS.

• OVER BORROWING -THEREFORE HAVING LARGE MONTHLY LOAN REPAYMENTS, WHICH HAVE TO BE MET.

CASH FLOW FORECASTS

• A CASH FLOW FORECAST IS A MANAGEMENT ACCOUNTING DOCUMENT, WHICH OUTLINES THE FORECASTED FUTURE CASH INFLOWS (FROM SALES) AND THE OUTFLOWS (RAW MATERIALS, WAGES, ETC) PER MONTH FOR A BUSINESS OVER AN ACCOUNTING PERIOD.

CASH FLOW FORECASTS

• STARTING UP A BUSINESS: IN THE FIRST MONTHS OF A BUSINESS, A LOT OF CAPITAL WILL BE NEEDED. THE PROBLEM IS, NOT EVERYBODY REALIZES THAT THE AMOUNT OF MONEY THEY NEEDED IS MUCH MORE THAN THEY HAD EXPECTED. THEREFORE, A CASH FLOW FORECAST WILL GIVE THEM A BETTER IDEA OF HOW MUCH MONEY WILL BE NEEDED.

CASH FLOW FORECASTS

• KEEPING THE BANK MANAGER INFORMED: IT NEEDS TO BE SHOWN TO THE BANK TO INFORM IT OF THE SIZE OF THE NEEDED LOAN/OVERDRAFT, WHEN IT IS NEEDED, HOW LONG IT IS NEEDED AND WHEN IT COULD BE REPAID. ONLY THEN WILL THE BANK GIVE YOU A CHANCE TO GET A LOAN.

CASH FLOW FORECASTS• RUNNING AN EXISTING BUSINESS: IT IS IMPORTANT

TO KNOW THE CASH FLOW OF A BUSINESS SO THAT LOANS COULD BE ARRANGED IN ADVANCE IN ORDER TO GET THE LEAST INTEREST POSSIBLE. IF A FIRM HAS CASH FLOW PROBLEMS AND GOES TO THE BANK FOR A LOAN FOR THE NEXT DAY, IT WILL CHARGE HIGH INTERESTS BECAUSE IT KNOWS THAT THE BUSINESS HAS NO CHOICE. ALSO, IF A BUSINESS EXCEEDS THEOVERDRAFT LIMIT WITHOUT INFORMING THE BANK, IT COULD BE ASKED TO REPAY THE OVERDRAFT IMMEDIATELY AND COULD RESULT IN CLOSURE OF THE BUSINESS.

CASH FLOW FORECASTS

• MANAGING CASH FLOW: IF A BUSINESS HAS TOO MUCH CASH, IT SHOULD PUT THE CASH TO SOME GOOD USE QUICKLY. SOME EXAMPLES OF THIS IS: REPAYING ALL LOANS FOR LESS INTEREST, PAYING CREDITORS IMMEDIATELY TO GET DISCOUNTS.

CASH FLOW FORECASTSTotal $ Jan Feb Mar Apr

Sales revenue

2850 900 850 750 350

Other revenue

650 200 200 100 150

Total cash inflows

3500 1100 1050 850 500

Total cash outflows

3400 700 950 1200 550

Net monthly cash flow

100 400 100 (350) (50)

Bank balance 300 600 700 350 300

• JAN• CASH INFLOWS OF $1,100 • CASH OUTFLOWS OF $700• POSITIVE NET MONTHLY CASH

FLOW OF $400• NET MONTHLY CASH FLOW +

PREV BANK BALANCE = BANK BALANCE• $600

CASH FLOW FORECASTS• MAR AND APR• NEGATIVE NET MONTHLY

CASH FLOWS

• THIS GRADUALLY REDUCES THE BANK BALANCE

Total $ Jan Feb Mar AprSales revenue

2850 900 850 750 350

Other revenue

650 200 200 100 150

Total cash inflows

3500 1100 1050 850 500

Total cash outflows

3400 700 950 1200 550

Net monthly cash flow

100 400 100 (350) (50)

Bank balance 300 600 700 350 300

CASH FLOW FORECASTS• IT IS IMPORTANT FOR A BUSINESS TO PRODUCE A CASH

FLOW FORECAST, SO THAT IT CAN PREPARE FOR THOSE MONTHS IN WHICH IT IS FORECAST TO EXPERIENCE A CASH FLOW CRISIS (I.E. THE BUSINESS NEEDS TO ARRANGE EXTRA BORROWING OR OVERDRAFT FACILITIES TO PROVIDE EXTRA CASH).• ALTERNATIVELY, IN THE MONTHS WHERE THE BUSINESS

IS FORECAST TO BE CASH-RICH, IT CAN USE THIS MONEY PROFITABLY ELSEWHERE WITHIN THE BUSINESS (E.G. NEW PRODUCT DEVELOPMENT).

HOW CAN CASH FLOW PROBLEMS BE SOLVED?

• HERE ARE SOME STEPS TO SOLVE CASH FLOW PROBLEMS:• ARRANGE FOR FUTURE LOANS WITH THE BANK WHEN YOU

ANTICIPATE NEGATIVE CASH FLOW.• REDUCE OR DELAY PLANNED EXPENSES UNTIL CASH IS

AVAILABLE, E.G. ASK TO PAY IN CREDIT.• INCREASING FORECASTED CASH INFLOW, E.G. BY

GETTING A PART-TIME JOB.