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cash flow forecasting and working capital (cash flow forecast (starting up…
cash flow forecasting and working capital
why cash is important to a business
if a business has too little cash
unable to pay workers, suppliers, landlord, government
production of goods and services will stop-workers will not work for nothing and suppliers will not supply if they're not paid
the business may be forced in to "liquidation"- selling up everything it owns to pay its debts
what is meant by cash flow?
cash inflow
the sale of products for cash
payments made by debtors
borrowing money from an external source (repaid eventually)
the sale of assets of the business
investors (shareholders)
cash outflow
purchasing goods or materials for cash
paying wages, salaries and other expenses
purchasing fixed assets
repaying loans
paying creditors
cash flow cycle
to pay for essential materials and other costs
required to produce the product
product is sold to the customers
if customers receive credit, they don't have to pay right away
money will be needed to pay for buying further materials
not enough cash at stage 1?
not enough materials and other requirements could be purchased. output and sales fall
a business insisted on its customer paying cash at stage 4 because the business was short of money?
might lose customer if competitor business offers credit
a business has insufficient cash to pay bills (rent n electricity)?
would be in liquidity crisis and it might be forced out of business by its creditors
a profitable business can run out of cash. (
insolvency
)
how?
allowing customers too long a credit period, perhaps to encourage sales
purchasing too many fixed assets at once
expanding too quickly and keeping a high inventory level. cash is used to pay for higher inventory levels. often called
overtrading
cash flow forecast
to tell the manager
how much cash is available for paying bills, repaying loans or for buying fixed assets
how much cash the bank might need to lend to the business in order to avoid insolvency
whether the business is holding too much cash which could be put to a more profitable use
starting up a business
owners will need to know how much cash will be needed in the first few months of operation
premises have to be purchased/rented
machinery must be purchased/hired
inventory must be built up
advertising and promotion costs will be necessary to make consumers aware of the product or service
many business fail because owners do not realize how much cash is needed in the first few crucial months
keeping the bank managers informed
bank managers will need to see the firm's cash flow forecast before lending them any money
they will see how big a loan/overdraft is needed
managing an existing business
business could run out of cash perhaps due to purchasing an expensive fixed asset or fall in sales
borrowing money needs to be planned in advanced, low rates of interest can be arranged
banks might refuse to give loan if being asked the day before because of poor business planning, charged high rates
if the business exceeds overdraft limit without telling the bank manager, the bank could insist that the overdraft is repaid immediately and this could force business to close
managing cash flow
too much cash held in the bank account of a business means that this capital could be better used in other areas
if the business seems likely to have a high bank balance, the accountant could decide to pay off loans to help reduce interest charges
pay creditors quickly to take advantage of possible discounts
importance of working capital
working capital = current assets - current liabilities
in different forms
cash is needed to pay for day-to-day costs and inventories
the value of a firm's debtors is related to the volume of production and sales. to achieve higher sales there may be need to offer additional credit facilities.
the value of inventories is also a significant part of working capital. not enough inventories may cause production to stop. a very high inventory level results in high opportunity cost
overcoming cash flow problems
increasing bank loans
bank loans will inject more cash into the business
interest must be paid (reduce profits)
loans will have to be paid eventually (cash outflow)
delaying payments to suppliers
cash outflows will decrease in short term
suppliers could refuse to supply
supplier could offer lower discounts for late payments
asking debtors to pay more quickly (or insisting only on cash sales)
cash inflows will increase in the short term
customers may take their custom to another business that still offers time to pay
delaying or cancel purchases of capital equipment
cash outflows for purchase of equipment will decrease
the long-term efficiency of the business could decrease without up-to-date payment
solution?
attracting new investors
; sell more company shares, but will ownership be affected?
cutting costs and increasing efficiency
; but will this be popular with employees and could product quality be affected?
developing new products that will attract more customers
; could take a long time and needs cash in the short term to pay for development