Chapter 27 (forecasting cash flows) Flashcards Preview

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Flashcards in Chapter 27 (forecasting cash flows) Deck (23):

what is Liquidation?

Liquidation occurs when a firm ceases trading and its assets are sold for cash to pay suppliers and other


what is cash flow forecast?

A cash-flow forecast is an estimate of a firm’s future
cash inflows and outflows


what is net monthly cash flow?

The net monthly cash flow is an estimated difference
between monthly cash inflows and outflows


what is the opening cash balance?

The opening cash balance is the cash held by the
business at the start of the month


what is the closing cash balance?

The closing cash balance is the cash held at the end
of the month becomes next month's opening


what are the benefits of Cash-flow forecasting?

1.additional finance.
By showing periods of negative cash flow, plans can be put into place to provide additional finance.

2.reduction of negative cash flow.
If negative cash flows appear to be too great, then plans can be made for reducing these

3.current business proposal.
A new business proposal will never progress beyond the initial planning stage unless investors and bankers have access to a cash-flow forecast


what are the limitations of Cash-flow forecasting?

1.Lack of planning.
Cash-flow forecasts help greatly in predicting future cash problems for a business. However, they do not solve cash-flow problems by themselves

2.Poor credit control.
The credit-control department of a business keeps a check
on all customers’ accounts – who has paid, who is keeping to agreed credit terms and which customers are not paying on time. If this credit control is inefficient and badly managed, then debtors will not be ‘chased up’ for payment and potential bad debts will not be identified.

3. Allowing customers too long to pay debts.
allowing customers too long to pay means reducing short-term cash inflows, which could lead to cash-flow problems.

4.Expanding too rapidly
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.

5.Unexpected events
A cash-flow forecast can never be guaranteed to be 100% accurate. Unforeseen events could increase costs


what is Overtrading?

Overtrading means expanding a business rapidly without obtaining all of the necessary finance so that a cash-flow shortage develops


method of improving cash flow: Overdraft

how it works:
Flexible loans on which the business can draw as necessary up to an agreed limit

possible drawbacks:
1.Interest rates can be high – there may be an overdraft arrangement fee
2.overdrafts can be withdrawn by the bank and this often causes insolvency


method of improving cash flow: Short-term loan

how it works:
A fixed amount can be borrowed for an agreed length of time

possible drawbacks:
1.The interest costs have to be repaid
2.The loan must be repaid by the due date


method of improving cash flow: Sale of assets

How it works:
Cash receipts can be obtained from selling off redundant assets, which will boost cash inflow

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


method of improving cash flow: Sale and leaseback

How it works:
Assets can be sold, e.g. to a finance company, but the asset can be leased back from the new

Possible drawbacks:
1.The leasing costs add to annual overheads
2.There could be a loss of potential profit if the asset rises in price
3.The assets could have been used as collateral for future loans


method of improving cash flow: Reduce credit terms to customers

How it works:
Cash flow can be brought forward by reducing credit terms
from, say, two months to one month

Possible drawbacks:
1.Customers may purchase products from firms that offer extended credit terms


method of improving cash flow: Debt factoring

How it works:
Debt-factoring companies can buy the customers’ bills from a business and offer immediate cash – this reduces risk of bad debts too

Possible drawbacks:
1.Only about 90-95% of the debt will now be paid by the debt-factoring company – this reduces profit
2.The customer has the debt collected by the finance company – this could suggest that the business is in trouble


method of improving cash flow: Delay payments to suppliers (creditors)

How it works:
Cash outflows will fall in the short term if bills are paid
after, say, three months instead of two months

Possible drawbacks:
1.Suppliers may reduce may discount offered with the purchase
2.Suppliers can either demand cash on delivery or refuse to supply at all if they believe the risk of not
being paid is to great


method of improving cash flow: Delay spending on capital equipment

How it works:
By not buying equipment, vehicles, etc., cash will not have to be paid to suppliers

Possible drawbacks:
1.The efficiency of the business may fall if outdated and inefficient equipment is not replaced
2.Expansion becomes very difficult


method of improving cash flow: Use leasing, not outright purchase of capital equipment

How it works:
The leasing company owns the asset and no large cash outlay is required

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


method of improving cash flow: Cut overhead spending that does not directly affect output, e.g. production costs

How it works:
These costs will not reduce production capacity and cash
payments will be reduced

Possible drawbacks:
1.Future demand may be reduced by failing to promote
the products effectively


Managing working capital: debtors

-Not extending credit to customers – or extending it for
shorter time periods

-Selling claims on debtors to specialist financial institutions
acting as debt factors

-By being careful to discover whether new customers are
credit worthy

-By offering a discount to clients who pay promptly


Managing working capital: Credit / creditors

*Creditors are suppliers who have agreed to supply products on credit and who have not yet been paid*

Credit can be managed in two main ways:
1.Increasing the range of goods and services brought on
2.Extend the period of time taken to pay


Managing working capital: Inventory

1.Keeping smaller inventory levels
2.Using computer systems to record sales, inventory levels and ordering as required
3.Efficient inventory control, inventory use and inventory


Managing working capital: Cash

1.Use of cash-flow forecasts – these can help the
management of cash flows and working capital
2.Wise use of investment of excess cash
3.Planning for periods when there might be too little cash
and arranging for overdraft facilities from the bank to
avoid a liquidity crisis


Just-in-time inventory ordering (JIT)

by reducing inventory holdings using this technique, and by only producing when orders have been received, working capital tied up in inventories will be minimised.

Getting goods to customers as quickly as possible will speed up the eventual payment received for these products.