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3.7 CASH FLOW (LIQUIDATION:
When a firm ceases trading and its assets are…
3.7 CASH FLOW
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Cash flow : The sum of cash payments to a business (inflows) less the sum of cash payments made by it (outflows).
Cash outflows : Payments is cash made by a business, such as those to suppliers and employees.
Cash inflows : Payments in cash received by a business, such as those from customers (debtors) or from the bank; e.g. receiving a loan.
Working capital : The capital needed to pay for raw materials, day-to-day running costs and credit offered to customers.
Working capital = current assets - current liabilities.
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WORKING CAPITAL CYCLE:
The period of time between spending cash on the production process and receiving cash payments from customers
The consequences of not meeting payments when they are due are, for example; staff refusing to work, suppliers unwilling to provide raw materials or any number of supplies, or for that matter the electricity being turned off and eviction notices being issued for non-payment of rent.
Working Capital Cycle: The period of time between spending cash on the production process and receiving cash payments from customers.
CAUSES OF CASH FLOW PROBLEMS:
- Lack of planning
- Poor credit control
- Allowing too much credit
- Expanding too rapidly
- Unexpected events
LIMITATIONS OF CASH FLOW FORECASTS:
- Mistakes can be made in preparing the revenue and cost forecast (inexperience, seasonal variations, etc)
- Unexpected cost increases can lead to major inaccuracies (e.g. fluctuations in oil prices affecting cash flows of airline companies)
- Wrong assumptions can be made in estimating the sales of a business (e.g., poor market research)
BENEFITS OF CASH FLOW FORECAST:
- By showing periods of negative cash flow, plans can be put into place to provide additional finance; e.g. arranging a bank overdraft or preparing to inject owner's capital
- If negative cash flow appears to be too great, then plans can be made for reducing these; e.g., by cutting down on purchases of new materials or reducing credit sales
- A new business proposal will never progress beyond the initial planning stage unless investors and bankers have access to a cash flow forecast (and the assumptions behind it)
CASH FLOW FORECASTS
- Forecasting cash inflows:
Owner's own capital injections
Bank loan payments
Customers cash purchases
Debtors payments
- Forecasting cash outflows, examples include:
Lease payment for premises
Annual rent payment
Electricity, water and telephone/internet bills
Labour cost payments
Variable cost payments; e.g. raw materials
CREDIT CONTROL
Credit control: Monitoring of debts to ensure that credit periods are not exceeded
BAD DEBTS
Bad debts: Unpaid customers' bills that are now very unlikely to ever be paid.