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Cash flow forecasting and working capital - Coggle Diagram
Cash flow forecasting and working capital
Why cash is important to a business
cash is a liquid asset
it is immediately available for spending on goods and services
cash flow means the flow of money into and out of a business over a certain period of time
cash flow problems can incur
being unable to pay workers, suppliers, landlord, government
production of goods and services will also stop
the business may be force into "liquidation"
Define cash flow
Ways that cash inflow
sale of products for cash
payments made by debtors
borrowing money from an external source
the sales of assets of the business like unwanted property
investors, like shareholders investing in the business
Ways that cash outflow
purchasing goods or materials for cash
paying wages, salaries, and other expenses in cash
purchasing non current assets
repaying loans
be paying creditors of the business
Explain why cashflow forecast is so important
it is important for the manager of a business to know what cash will be available month by month
Can be used to tell
how much cash is available for paying bills, repaying loans, or for buying fixed assets
how much cash the bank might need to lend the business to avoid insolvency
whether the business is holding too much cash to be put to a more profitable use
Uses
Starting up a business
when planning to start a business, the owner needs to know how much cash will be needed in the first few months of operation
a very expensive time for new businesses
premises have to be rented or purchased
machinery must be hired or purchased
inventory must be built up
advertising and promotion is also required
many businesses fail because owners do not realise how much cash is needed in these first few crucial months
Keeping the bank manager informed
banks provide loans to businesses
this applies to both new and existing businesses
in order for banks to lend money, they need to see the firm's cash flow forecast
the bank manager needs to see
how big a loan or overdraft is needed
when it is needed
how long the finance is needed for
when it would be repaid
it is very rare for banks to offer loans without a cash flow forecast
Managing an existing business
any business could run out of cash and require loans
if the business doesn't do cash flow forecasting, they may be unable to identify the lowest rates of interest or to get a loan at all
asking for an immediate loan would likely result in refusal due to poor business planning or high interest rates
not to mention, a business spending an overdraft without notice could result in the business needing to repay immediately
this could result in the business shutting down
Managing cash flow
too much cash held by a business means that there would be potentially wasted capital
which otherwise could be used to improve the business
the accountant could also decide to use this high balance to pay off loans to help reduce interest
another option is paying creditors early for potential discounts
What is it not
p r o f i t !
Define net cashflow
the difference between the business's cash inflows and outflows
total cash inflow - total cash outflow
Define liquidity
the ability of the company to pay back its short term debts
Elements that determine the length of a cash flow cycle
time to procure essential materials to produce goods
time required to product the goods themselves
time needed to sell the goods to customers
time needed to receive the payments from customers
Define credit sales
payments that are not made until several days or weeks after a product has been delivered
How to overcome a short term cash flow problem
Method
Increasing bank loans
banks loan will increase cash inflow
Limitations
interest must be paid
the loans will have to be repaid eventually
Delaying payments to suppliers
cash outflows will decrease in the short term
Limitations
suppliers could refuse to supply
suppliers could offer lower discounts for less payments
Asking debtors to pay more quickly
cash inflows will increase short term
Limitations
customers may go to other businesses that offer trade credit
Delay or cancel purchases of capital equipment
cash outflows for purchase of equipment will decrease
Limitations
the long term efficiency of the business could decrease without up to date equipment
Ways a business could improve its working capital
Attracting new investors
selling more company shares
Limitations
could potentially lose control of the business
Cutting costs and increasing efficiency
Limitations
employees may disagree
product quality may be affected
Developing new products
in order to attract more customers
Limitations
could take a long time
needs cash in short term to pay for development
Concept and importance of working capital
working capitals refers to the amount of capital readily available to the business
current assets - current liabilities
lifeblood of the business
having enough working capital assists in raising the credit reputation of a business
balance is necessary to run efficiently
businesses with ample working capital is always in the position to take advantage of any beneficial opportunity
this could used be to
buy raw materials being offered at a discount
implement a customer's special order
can be held in many different forms
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
inversely, a very high inventory level may result in very high opportunity costs
the overall success of a business depends upon its working capital position
it has to be handled property because
it shows the efficiency of the business
it also shows the business's financial strength