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Cash Flow Forecasting and Working Capital (Cash Flow Forecast (Starting up…
Cash Flow Forecasting and Working Capital
Why Cash Flow is important to the business
If a business has to 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 flows
Cash inflow
The sale of products for cash
Payments made by debtors - debtors are customers who have already purchased products from the business but did not pay for them at the time
Borrowing money from an external source
The sale of assets of the business, for example unwanted property
Investors- for example shareholders in the case of companies - putting more money into the business
Cash Outflow
Purchasing goods or materials for cash
Paying wages, salaries and other expenses in cash
Purchasing fixed assets
Repaying loans
By paying creditors of the business - other firms who supplied items to the business but who were not paid immedietly
Cash Flow Cycle
To pay for essential materials and other costs
Required to produce the product
Time needed to produce the products before they can be sold to customers
If these customers received credit, they will not have to pay straightaway, or they can pay in cash
Money will be needed to pay for buying further materials, etc.
Cycle repeats
Not enough cash at stage 1?
Not enough materials and other requirements could be purchased and so output and sales would fall
Pressuring the customer to pay cash on stage 4
because the business was short of money might lose the customer to a competitor who could offer credit.
Business has insufficient cash to pay its bills such as rent and electricity?
It would be a liquidity crisis and it might be forced out of business bu its creditors
Insolvency
When a profitable business runs out of cash, how?
Allowing customers too long a credit period, perhaps to encourage sales
Pushing too many fixed assets at once
Expanding too quickly and keeping a high inventory level. This means that cash is used to pay for higher inventory levels. This is often called overtrading
Cash Flow Forecast
Uses 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 more profitable use
Starting up a business
The owner will need to know how much cash will be needed in the first few months of operation
Premises have to be purchased or rented
Machinery must be purchased or hired
Inventory must be built up
Advertising and promotion costs will be necessary to make consumers aware of the product or service
Many new businesses fail because owners do not realize how much cash is needed in the first few crucial months
Managing an existing business
Any business can rut out of cash and require an overdraft, perhaps because of an expensive fixed asset being bought or a fall in sales
Borrowing money need to be planned in advance so that the lowest rates of interest can be arranged
Telling the bank today that a loan is needed tomorrow could lead to the bank either refusing the loan or charging high rates of interest
If the business exceeds the overdraft limit from the bank without informing the bank manager first, the bank could insist that overdraft is repaid immediately and this could force the business to
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Keeping the bank manager informed
Banks provide loans to businesses
Bank managers to need to see the firm's cash flow forecast, before lending any money
The bank manager will need to see how big a loan or overdraft is needed, when it is needed, how long the finance is needed for and when it might be repaid
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 of the business
If the business seems likely to have a very high bank balance, the accountant could decide to pay off loans to help to reduce interest charges
Pay creditors quickly to take advantage of possible discounts.
How to overcome cash flow problems
Increasing bank loans
Bank loans will inject more cash into the business
Interest must be paid - this will reduce profits
The loans will have to be repaid eventually - a cash outflow
Delaying payments to suppliers
Cash outflows will decrease in the short term
Suppliers could refuse to supply
Supplier could offer lower discounts for late payments
Asking debtors to pay more quickly (or insisting on only cash sales)
Cash inflows will increase in the short term
Customers may take their custom to another business that still offers time to pay - i.e. trade credit
Delay 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 equipment
Long-term solutions
Attracting new investors
, for example by selling more company shares - but this could affect the ownership of the business
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
- this could take a long time and needs cash in the short term to pay for development
The importance of working capital
Working capital = current assets - current liabilities
Held in different forms:
Cash is needed to pay day to day costs and buy inventories
The value of a firm's debtors is related to the volume of production and sales. to achieve higher sales there may be a need to offer additional credit facilities
The value of inventories is also a significant part of working capital. Not having enough inventories may cause production to stop. On the other hand, a very high inventory level may result in high opportunity costs