forecasting and managing cash flows chapter 30

Question 1

cash flow

Answer 1

the sum of cash payments to a business less the sum of cash payments from the business

Question 2

insolvent

Answer 2

when a business cannot meet its short term debts

Question 3

cash flow forecast

Answer 3

an estimate of the future cash inflows and outflows of a business

Question 4

what is the purpose of a cash flow forecast

Answer 4

for a business to survive, having sufficient cash to pay suppliers, banks and employees is an important factor. even if a business with high revenue and low expenses it could still lead to negative cash flow. without positive cash flow, any company-no matter how promising its business model- will become insolvent and bankrupt.

Question 5

why are cash flow forecasts important for entrepreneurs starting new businesses

Answer 5

new business start ups are often offered much shorter credit to pay suppliers than larger firms. banks and other lenders will need to see evidence of a cash flow forecast before making any finance available. finance is often very tight at start up, so accurate planning is much more significant for new businesses

Question 6

what is the meaning of forecasting cash flow

Answer 6

it means to trying to estimate future cash inflows and cash outflows, usually on a month by month basis

Question 7

cash inflow

Answer 7

cash payments into a business

Question 8

cash outflow

Answer 8

cash payments out of a business

Question 9

structure of a cash flow forecast

Answer 9

it is typically constructed monthly, often for the next 12 months, but it can cover a shorter time period. it has three sections which are cash inflows, cash outflows, net cash flow and opening and closing balance.

Question 10

net cash flow

Answer 10

estimated difference between cash inflows and cash outflows for the period

Question 11

opening cash balance

Answer 11

cash held by the business at the start of the month

Question 12

closing cash balance

Answer 12

cash held by the business at the end of the month, which becomes the next month’s opening balance

Question 13

section of cash flow forecasts: cash inflows

Answer 13

this section records the cash payments to the business, including cash sales, payments for credit sales, and capital inflows

Question 14

section of cash flow forecasts: cash outflows

Answer 14

this section records the cash payments made by the business, including wages, materials, rent and other costs

Question 15

section of cash flow forecasts: net cash flow and opening and closing balance

Answer 15

this shows the net cash flow for the period and the cash balances at the start and end of the period and the cash balances at the start and end of the period (the opening and closing balance). if the closing balance is negative (shown by a figure in brackets), then a bank overdraft will almost certainly be necessary to finance this

Question 16

formula of the the closing cash balance

Answer 16

opening cash balance + (cash inflows - cash outflows)
this closing balance becomes the opening balance for the next month

Question 17

benefits of cash flow

Answer 17

they show negative cash flow which means that plans can be made to source additional finance
they indicate periods of time when negative net cash flows are excessive so that the business can plan to reduce these by taking measuring to improve cash flow
they are essential to all business plans because a business start up will never gain finance unless investors and bankers have access to a cash flow forecast and the assumption behind it

Question 18

limitations of cash flow forecasting

Answer 18

mistakes can be made in preparing the revenue and cost forecasts, or they may be drawn up by inexperienced entrepreneurs or staff
unexpected cost increases lead to major inaccuracies in forecasts
incorrect assumptions can be made in estimating the sales of the business, perhaps based on poor market research. this will make the cash inflow forecasts inaccurate.

Question 19

causes of cash flow problems

Answer 19

there are several causes of cash flow problems like lack of planning, poor credit control, allowing customers too long to pay debts, expanding too rapidly and unexpected events

Question 20

causes of cash flow problems: lack of planning

Answer 20

cash flow forecasts help in predicting future cash problems for a business and financial planning can be used to predict potential cash flow problems so that managers can take action to overcome them in plenty of time. some businesses have insufficient plans for cash flow management.

Question 21

causes of cash flow problems: poor credit control

Answer 21

if credit control is badly managed, then trade receivables will not be chased for payment and potential bad debts will not be identified

Question 22

credit control

Answer 22

monitoring of debts ensure that credit periods are not exceeded. the credit control department of a business keeps a check on all customers’ accounts. they record who has paid, who is paying on time and which customers are not paying on time

Question 23

bad debt

Answer 23

unpaid customers’ bills that are now very unlikely to be ever paid

Question 24

overtrading

Answer 24

expanding a business rapidly without obtaining all of the necessary finance, resulting in a cash flow shortage

Question 25

causes of cash flow problems: allowing customers too long to pay debts

Answer 25

many businesses have to offer trade credit to customers in order to be competitive. a customer may choose product that allow trade credit because this improves their cash flow. allowing customer too long to pay reducing short term cash inflows, which leads to cash flow problems.

Question 26

causes of cash flow problems: expanding too rapidly

Answer 26

when a business expands rapidly, it has to pay for the expansion and for increased wages and materials months before it receives cash from additional sales. this overtrading can lead to serious cash flow shortages even though the business is successful and expanding

Question 27

causes of cash flow problems: unexpected events

Answer 27

unforeseen increases in costs and could lead to negative net cash flows not being indicated on the original cash flow forecast. factors such as the breakdown of the delivery truck can make the original cash flow forecast inaccurate

Question 28

methods of improving cash flow

Answer 28

cash flow can be improved by increasing cash inflows or reducing cash outflows. care needs to be taken here. the aim is to improve the cash position of the business, not revenue or profit

Question 29

method of increasing cash inflow: overdraft

Answer 29

a flexible sources of cash from a bank which a business can draw on as necessary up to an agreed limit

Question 30

method of increasing cash inflow: short term loan

Answer 30

a fixed amount can be borrowed for an agreed length of time

Question 31

method of increasing cash inflow: sale of assets

Answer 31

cash receipts can be obtained from selling off redundant assets, which will boost cash inflow

Question 32

method of increasing cash inflow: sale and leaseback

Answer 32

assets can be sold, but the assets can be leased back from the new owner

Question 33

method of reducing cash outflow: delay capital expenditure

Answer 33

by not buying equipment, vehicles etc. cash will not have yo be paid by suppliers

Question 34

method of reducing cash outflow: use leasing, not outright purchase, of capital equipment

Answer 34

the leasing company owns the asset and no large cash outlay is required

Question 35

drawback of overdraft to increase cash inflows

Answer 35

Interest rates can be high and there may be an arrangement fee.
Overdrafts can be withdrawn by the bank, which often causes insolvency.

Question 36

drawback of short term loan to increase cash inflows

Answer 36

The interest costs have to be paid.
The loan must be repaid by the due date.

Question 37

drawback of sale of assets to increase cash inflows

Answer 37

Selling assets quickly can result in a low price.
The assets might be required at a later date for expansion.
The assets could have been used as collateral for future loans.

Question 38

drawback of sale and leaseback to increase cash inflows

Answer 38

The leasing costs add to annual overheads.
There could be loss of potential profit if the assets rise in price.
The assets could have been used as collateral for future loans.

Question 39

drawbacks of delay capital expenditure to reduce cash outflows

Answer 39

The efficiency of the business may fall if inefficient equipment is not replaced.
Expansion becomes very difficult.

Question 40

drawbacks of using leasing, not outright purchase, of capital equipment to reduce cash outflows

Answer 40

The asset is not owned by the business.
Leasing charges include an interest cost and add to annual overheads.

Question 41

improving cash inflow by managing trade receivables

Answer 41

ways trade receivables can be managed to improve cash inflow are by not extending credit, to customers or asking customers to pay more quickly, selling claims on trade receivables to specialist financial institutions called debt factors, finding out whether new customers are credit worthy or offering a discount to customers who pay monthly

Question 42

improving cash inflow by managing trade receivables: not extending credit, to customers or asking customers to pay more quickly

Answer 42

Many customers now expect credit and will go elsewhere if it is not offered. The marketing department might argue for an increase in credit terms to customers at the same time as the finance department is trying to cut down on them.

Question 43

improving cash inflow by managing trade receivables: selling claims on trade receivables to specialist financial institutions called debt factors

Answer 43

These businesses will buy debts from other concerns that have an immediate need for cash. This will involve a cost, however, as the debt factors will not pay 100% of the value. They must make a profit for themselves.

Question 44

improving cash inflow by managing trade receivables: finding out whether new customers are credit worthy

Answer 44

This can be done by requiring references, either from traders or from the bank, or by using the services of a credit enquiry agency.

Question 45

improving cash inflow by managing trade receivables: offering a discount to customers who pay monthly

Answer 45

Although cash might be paid quickly, discounts reduce the profit margin on a sale.

Question 46

method of reducing cash outflow: Cut overhead costs that do not directly affect output

Answer 46

These costs will not reduce production capacity and cash outflows will be reduced.

Question 47

drawbacks of Cutting overhead costs that do not directly affect output in reducing cash outflows

Answer 47

Future demand may be reduced by failing to promote the products effectively.

Question 48

ways in which cash outflow can be reduced by managing trade payables

Answer 48

it can be reduced by purchasing more supplies on credit and not cash or extending the period of time taken to pay

Question 49

ways in which cash outflow can be reduced by managing trade payables: purchasing more supplies on credit and not cash

Answer 49

If a business has a good credit rating, this may be easy, but in other circumstances it can be difficult. Discounts from suppliers for quick cash payment might be stopped. Some suppliers might refuse to offer credit terms.

Question 50

ways in which cash outflow can be reduced by managing trade payables: extending the period of time taken to pay

Answer 50

The larger a business is, the easier it is to insist on longer credit periods from suppliers. This will improve the business’s cash flow. Slow payment by larger businesses is often a great burden for the small businesses that supply them. Suppliers may be reluctant to supply products or to offer a good service if they consider that a business is a late payer.