5.2: Forecasting and cash flows

Question 1

Def. Cash Flow

Answer 1

Record of the cash received by a business over a period of time and the cash outflows from the business.

Question 2

Def. Liquidation

Answer 2

When a firm ceases trading and its assets are sold for cash to pay suppliers and other creditors

Question 3

Def. Iliquid

Answer 3

When a business cannot meet its short term debts

Question 4

Why is cash flow planning vital?

Answer 4

New business start ups are usually given less credit periods - less time to pay suppliers.
It is hard to convince banks or other lenders to lend if they have no trading record. There is also a need to pay back at the right times.

Question 5

Def. Cash inflows

Answer 5

Payments in cash received by a business, such as those from customers, debtors or from the bank. e.g receiving a loan.

Question 6

Def. Cash outflows

Answer 6

Payments in cash made by a business, such as those to suppliers and workers.

Question 6

Cash vs. Profit

Answer 6

Cash is not the same as profit. It is important to always have enough cash in the short term. Profit can wait to be earned in the long term - but cash payments are always being made.

Question 6

Structure of cash flow forecasts

Answer 6

1. Cash in:
   Cash sales, credit sales, total inflow
2. Cash out:
   Raw materials, wages, other costs, total outflow
3. Net monthly cash flow, calculated by (total cash inflow - total cash outflow)

Question 6

Def. Opening cash balance

Answer 6

Cash held by the business at the start of the month.

Question 7

What are the causes of cash flow problems? (5)

Answer 7

Lack of planning
Poor credit control
Allowing customers too long to pay debts
Expanding too rapidly
Unexpected events.

Question 7

Cash Flow problems: Lack of planning

Answer 7

Cash flow forecasting - planning the future ahead doesn’t prevent any cash flow problems from happening, but it can help prevent the cash flow problems from developing.

Question 8

Def. Closing cash balance

Answer 8

Cash held at the end of the month becomes next month’s opening balance.

Question 9

Cash Flow problems: Poor credit control

Answer 9

If the credit control is inefficient, the debtors will not be ‘chased up’ for payment and potential bad debts will not be identified.

Question 10

Def. Credit control

Answer 10

Monitoring of debts to ensure that credit periods are not exceed.

Question 11

Def. Bad debt

Answer 11

Unpaid costumers’ bills that are now very unlikely to ever be paid.

Question 12

Cash Flow problems: Allowing customers too long to pay debts

Answer 12

By allowing customers to pay on credit, it will aid the competition of the business against others. However letting customers too long to pay means reducing short term cash inflows, which would lead to cash flow problems.

Question 13

Cash Flow problems: Expanding too rapidly

Answer 13

When the business expands rapidly, it has to pay for expansion and increased wages… => overtrading would lead to cash flow shortages.

Question 14

Def. Overtrading

Answer 14

Expanding a business rapidly without obtaining all of the necessary finance so that a cash flow shortage develops.

Question 15

Cash Flow problems: Unexpected events

Answer 15

Unforeseen increases in costs - a breakdown of a delivery van that needs to be replaced etc. could lead to negative monthly cash flows.

Question 16

Ways to improve cash flow? (2)

Answer 16

Increasing cash inflows
* Reducing cash outflows

Question 17

Ways to increase cash inflows? (4)

Answer 17

Overdraft: Flexible loans businesses can draw up
Sale of assets: Cash receipts obtained from selling redundant assets
Reduce credits terms to customers: Shorten the period of time
Debt factoring: Companies offering immediate cash from the debt

Question 18

Ways to reduce cash outflows? (4)

Answer 18

Delay payments to suppliers/creditors: Take longer to pay back to decrease short term cash outflows
Delay spending on capital equipment
Use leasing instead of purchasing equipment
Cut overhead spending that does not directly affect output e.g. promotion costs

Question 19

Ways to manage working capital?

Answer 19

4 components need to be managed:
* Debtors
* Creditors
* Inventory
* Cash

Question 20

How to manage creditors? (2)

Answer 20

Increasing the range of goods and services bought on credit
Extend the period of time taken to pay

Question 20

How to manage debtors? (3)

Answer 20

Not extending credit to customers -extending it for shorter time periods
Selling claims on debtors to specialist financial institution acting as debt factoring
By discovering whether new customers are creditworthy

Question 20

How to manage inventory? (3)

Answer 20

Keeping smaller inventory levels
Using computer systems to record sales and inventory levels to order as required
Just in time production method

Question 21

How to manage cash? (3)

Answer 21

Use cash flow forecasts
Wise use of investment of excess cash
Arranging overdrafts when there might be too little cash