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Unit 5 - Finance Management (3) - Coggle Diagram
Unit 5 - Finance Management (3)
5.6 Cash Flow
Cash flow
the money that flows in and out of a business over a given period of time
Cash inflows
are received by a business
Cash outflows
are paid out by a business over a period of time.
Profit vs Cash flow
profit = sales revenue - total costs
net cash flow = cash inflow - cash inflow - cash outflow
Working Capital Cycle
is the money needed for the day-to-day running costs of a business. It is also known as the net current assets of a business.
formula: working capital = current assets - current liabilities
purchase of materials from suppliers
cash received from debtors
production of goods
goods sold on credit
Cash Flow Forecasts
These are the predictions of a firm's cash inflows and outflows over a given period of time.
This exists in a form of a financial document that shows expected month-by-month receipts and payments of a business that have not yet occurred.
constructing cash-flow forecasts
opening cash balance: the cash that a business starts with every month.
Total cash inflows: a summation of all the cash outflows during a particular month
total cash outflows: a summation of all the cash outflows during a particular month
net cash flow: difference between the total cash inflows and the total cash outflows
closing cash balance: estimated cash available at the end of the month. It is found by adding the net cash flow of one month to the opening balance of the same month
benefits of cash-flow forecasts
helps to clarify the purpose of the business and provides estimated projections for future performances
provides a good support base for businesses intending to apply for funding from financial institutions.
predicting cash flow can managers identify in advance periods where the business may need cash and plan accordingly to source it
assists in monitoring and managing cash flow. makes comparisons between the estimated cash flow figures and its actual figures
Dealing with Cash Flow Problems
reducing cash outflow
business will negotiate with suppliers or creditors so as to delay payment. this helps businesses to have working capital for its short-term needs.
purchases of fixed assets can be delayed. Assets such as machinery may take up a lot of cash for the business and delay purchases
business may decrease specific expenses such as advertising costs that will not affect production capacity
might be possible to source cheaper suppliers. This will help reduce costs on materials, decrease the outflow of funds
Improving cash inflows
business may insist that customers pay cash only for goods purchased. This avoids the problem of delayed payments from debtors.
offering discounts or incentives can encourage debtors to pay early. this will reduce the debt burden as they will pay less than earlier agreed.
firm may diversify its products offering. This will help avail a variety of goods on offer for sale to customers, potentially increasing sales
Limitations of Cash Flow Forecasting
unexpected changes in the economy: fluctuating interest rates could affect borrowing by firms and have a negative impact on its cash-flow needs
poor market research: improperly done sales forecasts due to poor demand predictions can have a negative effect on future cash sales
difficulty in predicting competitors' behavior: competitors may change their strategies often and make it hard for other businesses to predict their actions and compete with them
unforeseen machine or equipment failure: breakdown of machinery is difficult to predict, and it can drastically affect the cash position of businesses
demotivated employees: being demotivated can negatively affect the productivity of workers, reducing output or sales and leading to less cash inflow
5.7 Efficiency Ratio Analysis
Stock Turnover Ratio
ratio measures how quickly a firm's stock is sold and replaced over a given period of time.
Formula (year): Stock turnover ratio (number of times) = cost of goods sold/average stock
Formula (# of days): Stock turnover ratio (number of days) = average stock/cost of goods sold x 365
Debtors day
ratio measures the number of days it takes on average for a firm to collect its debts from customers it has sold goods to on credit
formula: debtor days ratio (number of days) = debtors/total sales revenue x 365
Creditors days
ratio measures the average number of days a firm takes to pay its creditors
formula: creditors days ratio (number of days) = creditors/cost of goods sold x 365
Gearing ratio
measures the extent to which the capital employed by a firm is financed from loan capital
loan capital is a long-term liability in the business
capital employed included loan capital, share capital
formula: Gearing ratio = loan capital/capital employed x100