managing cash flows chapter 1 denise nicholson [email protected]
TRANSCRIPT
What we will cover in this chapter:
• Differences between accounting to establish profit or loss and accounting for cash
• Working capital• What affects working capital• How the cash cycle can be measured.
WHY IS CASH DIFFERENT FROM PROFIT
• Profitability is the amount by which income exceeds expenditure, and can be seen as the overall wealth of the business
• We often use cash based receipts and payments as a starting point then make adjustments such as accruals and prepayments, depreciation etc
• The increase in the business wealth is known as profit
• This is the accruals system of accounting.
Cont.....
• Cash receipts and payments are normally recorded in the business’s cash book
• Receipts and payments are expressions that relate just to cash items and do not incorporate any of the adjustments that are used to calculate income and expenditure when calculating profit
• We must be careful to understand the distinction between these two sets of terms.
THE IMPORTANCE OF CASH
• A business needs to plan, monitor and control cash
• Cash is as important as profit because;– Daily operations of a business depend on it– The survival of a business depends on it.
WORKING CAPITAL AND THE CASH CYCLE
• Working capital is part of the net resources of the business that is made up of
current assets minus current liabilities• The cash cycle involves the circulation of the
elements of inventory (stock), receivables (debtors), cash and payables (creditors)
• The value of these elements will change on a daily basis.
Which of the following is not part of the working capital
Receivables Non-current assets
Payables Inventory
WORKING CAPITAL AND THE CASH CYCLE
Cash
Payables
Inventory
Receivables
CALCULATING THE CASH CYCLE
• The shorter the cash cycle, the fewer resources will be needed, as the business is making better use of its working capital
• Can be calculated in days, weeks or months• Cash cycle = inventory days + receivable days –
payable days.
CALCULATIONS
• Inventory (stock) Turnover
• Inventory days = inventory x 365cost of sales
CALCULATIONS
• Receivables’ (Debtors’) Collection Period
• Receivable days = receivables x 365credit sales
CALCULATIONS
• Payables’ (Creditors’) Payment Period
• Payable days = payables x 365credit purchases
Example
Statement of financial positionCurrent AssetsInventory 80000Receivables 93000Cash 17000Current LiabilitiesPayables 55000
Example
Income StatementSales 500000Less cost of salesOpening inventory120000Purchases 300000Less closing inventory(80000)
(340000)Gross Profit 160000
Example
• Inventory days = 80000/340000 x 365 days• 86 days• Receivable Days = 93000/500000 x 365 days• 68 days• Payable days = 55000/300000 x 365 days• 67 days• Cash cycle = 86 + 68 – 67 = 87 days
Activity
• Handout Cash Operating Cycle (Working Capital) typed
• Question 1 and 2 from chapter task handout (BPP)
• Handout Cash Operating Cycle (BPP p6/7)
Discussion
• Company Survival – Cash Operating Cycle is Key
• Why should I be concerned with it – Example page 2 of handout
• Activity – Comparison Handout
Liquidity Ratios• Current Ratio
Current AssetsCurrent Liabilities
• Acid Test Ratio (Quick Ratio)Current Assets less Inventory (Stock)
Current Liabilities
• Handout + Activity
Overtrading
Occurs when a business attempts to expand its level of trading and then has insufficient working capital and insufficient cash available to support that increased level of trading
Warning signs
Rapid increasing sales levels
Falling profit
margins
Inability to collect cash
promptly
Deterioration of cash balances
Over Capitalisation
• Over capitalisation is the opposite of overtrading. It involves having more resources tied up in working capital than is needed.
• Warning signs are;• High levels of cash• Payments being made to suppliers before they
are due
Activity
• Question 3 from BBP Handout (given out earlier)
• Activity 5 page 7 – Kaplan textbook
THE IMPORTANCE OF CASH FLOW
• When you think about a business you ask– Is it profitable?
• Profit is not enough!– Needs enough cash in the bank or overdraft
facility– To pay debts when they fall due (liquidity in
previous lesson)• A business must be profitable and also have
access to cash.
CASH AND PROFIT - DIFFERENCES
• Accruals concept– Revenues from sales and cost of goods sold are
accounted for in the period they are earned or incurred
• Accruals and Prepayments• Non cash expenses– Some expense incurred will have no affect on the
cash in a business e.g. Depreciation
FRS 18 Kaplan p 9
CASH AND PROFIT
• Purchase of fixed assets– Cash used to acquire the asset, appears on the
balance sheet – no effect on profit• Sale of fixed assets– Cash proceeds from the sale, however, only the
profit/loss on the sale will affect the profit of the business
• Receipts/payments not affecting profit– Examples include injections of capital, drawings,
shares
CASH AND PROFIT
• Which of the following has the same impact on the cash and the profit?A. Purchase of a new computer for the businessB. Accrual of an electricity accountC. Payment of monthly wagesD. Sale of a company car
CASH AND CREDIT TRANSACTIONS
• A cash transaction takes place with either coins, notes, cheque, credit or debit card. Money will be available in the business account as soon as deposits are made
• A credit transaction where receipt or payment is delayed due to agreed terms with either a customer or supplier, normally 30 or 60 days time
CASH AND CREDIT TRANSACTIONS
• In each of the following select the correct optionA. A cheque made out for the payment of rent is a [cash
transaction/credit transaction]B. Credit card sales of £800 is a [cash transaction/credit
transaction]C. Good purchased for £250 with payment made on
receipt of invoice is a [cash transaction/credit transaction]
D. Goods and invoice delivered to a customer today for payment in 30 days is a [cash transaction/credit transaction]
ACCRAULS CONCEPT
• Has a major impact on differences between cash flow and profit
• Discuss Worked example page 10 – text book• Discuss Worked example page 11 – text book
CALCULATING CASH FLOWS
• You will be required to:– Calculate actual cash received from receivables
using open and closing receivables balances and sales revenue
– Calculate actual cash paid to payables using open and closing payables balances and purchases
– Calculate actual cash paid for expenses using accruals and/or prepayments to adjust expenses
TASK
• Income statement for 3 months ended March show sales of £125,000, purchases of £80,000 and operating expenses of £15,000
31 March 1 JanuaryDebtors £10,000 £14,000
Creditors £11,000 £8,000
Accruals £2,000 £3,000
Calculate the cash flows for:
Sales £
Purchases £
Operating expenses £
TASK - ANSWERS
• Income statement for 3 months ended March show sales of £125,000, purchases of £80,000 and operating expenses of £15,000
31 March 1 JanuaryDebtors £10,000 £14,000
Creditors £11,000 £8,000
Accruals £2,000 £3,000
Calculate the cash flows for:
Sales £125,000 + £14,000 - £10,000 = £129,000
Purchases £80,000 + £8,000 - £11,000 = £77,000
Operating expenses £15,000 + £3,000 - £2,000 = £16,000
TASKS
• Activity 6 p 14 (together)• Activity 7 p 19• BPP Task 2.3
CAPITAL EXPENDITURE FIGURES
• From the balance sheet we can see fixed assets less accumulated depreciation
• From the profit and loss we can see the annual depreciation charge
• From this information we can calculate the amount of cash spent on fixed assets in the period
EXAMPLE
• Opening fixed assets of £100,000, closing balance of £120,000 and depreciation charge of £10,000
£
Opening balance 100,000
Less depreciation charge (10,000)
90,000
Closing balance 120,000
Cash expenditure 30,000
Student Tasks
• Example p 15 Purchase and Sale of non-current assets
• Disposals