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Chapter 17 - Forecasting and managing cash flows - Coggle Diagram
Chapter 17 - Forecasting and managing cash flows
The meaning and purpose of cash-flow forecasts
A cash flow forecast is produced to estimate the amount of cash that a business can anticipate having in a particular period
This type of forecast helps a business prepare for times when it might experience a shortfall in cash, my making arrangementns for an injection of cash in time to cover it
The estimate can prove to be inaccurate, not based on cash inflows and outflows that happened but a guess about what could happen in the future
Difference between cash and profit
Cash is money in the form of notes, coins or held in bank accounts that is readily available for a businesses purchase
Profit is the difference between sales revenue and costs, not money available to spend because some sales may have been credit only and payments might not have been received
Importance for a business of holding suitable amounts of cash
Cash allows a business to pay for items like wages
A business must have sufficient cash to meet its short term financial obligations
A profitable business can be declared illiquid (items that cant be sold for cash)
Holding too much cash creates opportunity cost, because the money could have been used in a beneficial way
Production of a cash flow forecast allows a business to monitor the level of cash in the business, to take timely action ensuring levels are maintained
Profitable businesses can fail due to cash flow issues
Uses of cash flow forecasts
Predict times when there might be a shortage of cash in the business (large payments made out, so a lack of cash to be made)
Plan foreseeable variations in cash flow: seasonable variants have an impact (tourist businesses)
To set targets (reduced spending targets)
Show potential lenders as proof of business growth
Construction of cash flow forecasts
Closing balance becomes the opening balance for the following month
Cash flow forecasts are usually constructed on a month-by-month basis to cover a 12-month period
Cash flow forecasts are based on historic fact and what is expected to happen in the future, like the purchase of future equipment
A new business faces difficulty because it doesnt have previous financial data on which to base its forecasts
Cash flow forecasts must be as realistic as possible because they are often required by bans, when a bank loan is requested
Interpretation of simple cash-flow forecasts from given data
A cash flow forecasts allow a business to assess cash flow shortfall, how long it will last, how big is it, what was the cause, is there months with cash surplus, how larger are the surpluses
Businesses have strategies to deal with this: surpluses are put to profitable use rather than lying unused, if there is predicted shortfall then arrange funds to cover it, check if cash inflows are delayed, postpone spending, wait it out
Amendment of cash flow in the light of changed circumstances
Forecasts are predictions or estimations of what can be expected to happen in the future
Forecasts might include value of sales, credit terms offered for customers, credit for suppliers, prices of goods and services, wage rates
Short term methods of improving cash flow
Reduce the credit period given to customers
Ask customers to pay more quickly
Discounts for earlier payment
Reduce costs
Renegotiating prices with suppliers
Increase price of goods and services sold
Success is dependent on reaction of customers
Increase in sales revenue
Initial cash outflow needed
Existing inventory sold at a reduced price
Extend credit periods to suppliers
Balance must be achieves between credit to customers and suppliers
Suppliers might incur cash flow issues, so might not be able to accept
Debt factoring
Debt of credit customers sold to a third party who will recover original value of debt
Customers may resent their debts being sold to others
Long term methods of improving cash flow
Sale and leaseback (inflow of funds without losing equipment)
Leasing (business never owns asset)
Sale of assets
Hire purchase (paid for over agreed time)
Link between cash flow and working capital
Working capital = current assets - current liabilities
Current assets consist of inventory, trade receivables, bank balances and cash in hand
Current liabilities consist of short term loans and trade payables
Effective management helps improve cash flow (inventory restricted, debtors monitored, credit terms with suppliers good)
Situations in which various methods of improving cash flow can be used
Debtors delaying payment requiring stricter control over which customers are given credit
Problem increases costs, then alternative suppliers might be the answer
Review of marketing strategies might solve a problem of falling sales revenue