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3.7 Cash Flow (Causes of cash flow problems (Poor credit control (credit…
3.7 Cash Flow
- If the suppliers and creditors are not paid in time, they can force the business into liquidation of its assets if it appears to be insolvent.
- Monitoring the weekly or monthly net cash flow
Liquidation - when a firm ceases trading and its assets are sold for cash
Insolvent - when a business cannot meet its short-term debts
Net cash flow - the sum of cash payments to a business (inflows) less the sum of the cash payments made by it (outflows)
Cash and Profit
- Cash and profit are two different things
- Cash outflows - payments in cash made by a business, such as those to suppliers and workers
- 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
Where does working capital come from?
working capital = current assets - current liabilitiescurrent assets - stocks, debtors and cash
- Most businesses obtain finance in the form of current liabilities; overdrafts and creditors etc.
However it is unwise because:
- they may have to be repaid at very short notice, meaning the firm is again left with a liquidity problem.
- It will leave no working capital for buying additional stoks or extending further credit to customers when required.
How much is needed?
The working capital requirement for any business will depend upon the "length" of the 'working capital cycle'
working capital cycle - the period of time between spending cash on the production process and receiving cash payments from customers.
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Cash flow forecasts
Forecasting cash inflows
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Bank loan payments - easy to forecast if they have been agreed with the bank in advance, both in terms of amount and timing
Customers' cash purchases - difficult to forecast as they depend on sales, so a sales forecast will be necessary - but how accurate this might be?
Debtors' payments - difficult to forecast as they depend on two unknowns. First, what is the likely level of sales on credit card, and second, when will the debtors actually pay?
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