Section 2.1.32 Planning and Cash Flow

Question 1

planning and cash flow

Answer 1

planning a firm’s financial requirements is helped by a clear, detailed business plan. cash flow is the flow of money into and out of a business in a given time period

Question 2

a good plan should be

Answer 2

persuasive to an outside investor and useful to the entrepreneur

Question 3

a good plan should explain

Answer 3

what makes the business special and help the entrepreneur to focus on what she or he is trying to achieve.

Question 4

a good plan will help

Answer 4

the outsider understand the risks and rewards involved in the proposal. the outsider could be a bank or ‘dragon’ type of investor interested in an ownership stake of the business

Question 5

a banks main concern is

Answer 5

that the start-up will be a safe investment

Question 6

a ‘dragon’ is mainly interested in

Answer 6

the upside potential - that is, the chance of making a huge profit

Question 7

either type of financier will want

Answer 7

to see a carefully prepared plan with a well-considered proposal for the sums of money needed

Question 8

the heart of a business plan should be based around

Answer 8

competitive advantage

Question 9

competitive advantage

Answer 9

identifying the features of your own product or service that will make it succeed against competitors. this may be based on a unique idea, a better product or service or the protection provided by a patent or copyright. on the other hand, a business may decide to strip a product or service down, to make it possible to be the cheapest in the market

Question 10

business plans usually contain:

Answer 10

1) executive summary
2) a product/service
3) the market
4) marketing plan
5) operational plan
6) financial plan
7) conclusion

Question 11

executive summary

Answer 11

• should be short, but compelling enough to persuade the busy banker to want to read on
• should say who you are, what the customer’s ‘pain’ is and how you will ‘relieve’ it
• why your team is ideal for the task
• how much capital you need for the start-up
• how much you are putting in yourself

Question 12

the product/service

Answer 12

• explain it from the customer’s point of view
• if others already offer the service, you must explain what is different about your idea

Question 13

the market

Answer 13

• focus on market trends rather than market size, such as whether the market is growing and, if so, how rapidly
• provide a brief analysis of key competitors

Question 14

marketing plan

Answer 14

• who are you targeting and how do you plan to communicate with them
• how expensive will this be
• there should be an explanation and justification for the prices you plan to set plus a forecast of likely sales per month for the first two years

Question 15

operational plan

Answer 15

• how will the product or service be produced and delivered
• could include production in china, which you will need to have already made contacts with willing suppliers

Question 16

financial plan

Answer 16

• the heart of this will be cash flow forecast
• this will give an idea of the bank balances over the start-up period, and therefore the financing needs

Question 17

conclusion

Answer 17

includes some idea of the longer-term plans for the business, including any ‘exit strategy’ - for example, a plan to sell the business within five years

Question 18

interpreting a cash flow forecast

Answer 18

• a cash flow forecast is carried out by estimating all the money coming into and out of the business, month by month
• these flows of money are then set onto a grid showing the cash movements in each month - and how those movements affect the overall cash holdings (closing balance)

Question 19

cash inflow

Answer 19

sums expected to arrive each month, either from financial sources or from customers

Question 20

cash outflow

Answer 20

planned payments per month, such as wages, paying suppliers and paying the landlord

Question 21

cash flow forecast is completed by calculating:

Answer 21

1) monthly balance
2) opening and closing balance

Question 22

monthly balance

Answer 22

• cash inflow for the month minus cash outflow
• shows each month if there is a positive or negative movement of cash
• when outflow is greater than inflow, the monthly balance will be negative

Question 23

opening and closing balance

Answer 23

• like a bank statement
• shows what cash the business has at the beginning of the month (opening balance) and what the cash position is at the end of the month (closing balance)

Question 24

closing balance

Answer 24

• closing balance is the opening balance plus the monthly balance
• the closing balance shows the overall state of the bank account at the end of the month

Question 25

what does cash flow forecast show

Answer 25

• as there is no such thing as negative money, the cash flow forecast shows that action is needed to avoid problems in the early months
• easiest remedy would be to negotiate a bank overdraft

Question 26

an unexpected payment is needed, such as a big fine for health and safety failings

Answer 26

• this increases the cash outflow
• which worsens the monthly balance
• which then worsens the closing balance for that month - and all the following opening and closing balances

Question 27

three main ways to analyse a cash flow forecast:

Answer 27

1) calculate the difference between the closing balance at the end of the period and the opening balance at the start
2) use the monthly closing balance to assess the trends in the data
3) analyze the timings and the cash inflows and outflows

Question 28

calculate the difference between the closing balance at the end of the period and the opening balance at the start

Answer 28

• gives a sense of what is happening over time
• if the overall cash balances are building up, then cash inflows are greater than cash outflows and the situation is comfortable
• if the balance is declining, urgent action may be necessary

Question 29

analyse the timings of cash inflows and outflows

Answer 29

• although some firms sell goods for cash, most provide customers with interest-free credit
• the longer the customers take to pay, the longer the seller is without their cash
• any method of speeding up costumer payments can boost a firm’s cash flow

Question 30

sum of money outstanding from customers is known as

Answer 30

receivables

Question 31

firms not only have customers, they also have

Answer 31

suppliers

Question 32

when buying goods on credit

Answer 32

the longer the credit period you can negotiate from suppliers, the longer your cash will be sitting in your bank account

Question 33

as the money sits in your bank account, this money owed is known as

Answer 33

payables

Question 34

if a company has customers who pay in 30 days and suppliers who are paid in 30 days, business call this

Answer 34

a ‘cash-to-cash’ figure of zero (which is fantastic)

Question 35

if customers take 60 days to pay but suppliers have to be paid in cash, that is

Answer 35

a cash-to-cash figure of 60 - which would put a strain on any business’ cash flow position

Question 36

if a business forecasts a period of negative cash flow, it can work to improve its positions in three ways:

Answer 36

1) getting goods to the market in the shortest possible time
2) getting paid as quickly as possible
3) keeping stick of raw materials to a minimum

Question 37

getting goods to the market in the shortest possible time

Answer 37

• the sooner goods reach the customer, the sooner payment is received
• production and distribution should be as efficient as possible

Question 38

getting paid as quickly as possible

Answer 38

• the ideal arrangement is to get paid cash on delivery
• most business, though, works on credit
• even worse, it is an interest-free credit, so the customer has little incentive to pay up quickly
• early payment should be encouraged by offering incentives, such as discounts for early payment

Question 39

keeping sticks of raw materials to a minimum

Answer 39

good stock management such as just-in-time system means that the business is not paying for stocks before it needs them for production

Question 40

cash flow can also be improved by

Answer 40

keeping cash in the business through minimizing short-term spending on new equipment

Question 41

things that the business can do to inprove cash flow and keep cash in the business include (and what they do):

Answer 41

1) leasing rather than buying equipment: this increases expenses but conserves capital
2) renting rather than buying buildings: this also allows capital to remain in the business
3) postponing expenditure - for example, on new company cars

Question 42

cash flow forecasts have their limitations, however:

Answer 42

• they are only as good as the raw data put in
• they risk giving the impression of certainty where none exists
• because of these things it is vital to allow for contingencies - that is, things that can wrong

Question 43

they are only as good as the raw data put in

Answer 43

entrepreneurs have to be optimistic by nature, so they may overestimate sales and underestimate operational difficulties (and therefore cash outflows)

Question 44

they risk giving the impression of certainty where none exists

Answer 44

especially at start-up, who knows how long business customers will take to pay

Question 45

because of these things it is vital to allow for contingencies - that is, things that can go wrong

Answer 45

so a clever cash flow forecast includes a planned overstatement of costs, to allow for unexpected problems

Question 46

best case:

Answer 46

an optimistic estimate of the best possible outcome - for example, if sales prove much higher than expected

Question 47

business plan:

Answer 47

a document setting out a business idea and showing how it is to be financed, marketed and put into practice

Question 48

cash flow forecast:

Answer 48

estimating future monthly cash inflows and outflows, to find out the net cash flow

Question 49

just-in-time:

Answer 49

ordering stick so that it arrives just before it is needed, just in time, i.e. having no stockpiles to cover for late deliveries

Question 50

overdraft:

Answer 50

short-term borrowing from a bank. the business only borrow as much as it needs to cover its daily cash shortfall

Question 51

worst case:

Answer 51

a pessimistic estimate assuming the worst possible outcome - for example, sales are very disappointing

Question 52

why is it important to ask who constructed the cash flow forecast

Answer 52

because unconscious bias may have slipped in, e.g. an entrepreneurs optimism may make the cash flow projections unrealistic

Question 53

why may it be a concern if a company’s sales are dominated by one large customer

Answer 53

because any disagreements about the invoice may lead to payment delays - which may be crippling if the bulk of cash inflow is due from that one customer

Question 54

why is cash flow often referred to as ‘the lifeblood’ of the business

Answer 54

partly because it’s that important to a business survival and partly because, like blood, you only think about it when something’s gone wrong

Question 55

why is it important to distinguish between slow payment and slow sales as causes of cash flow problems

Answer 55

slow payment is a purely cash-related issue that could be sorted out between accounts departments; slow sales may be a far more long-term problem - and will involve the marketing department

Question 56

why should a business analyse the causes of a cash problem before opting to increase its overdraft limits

Answer 56

because overdrafts are expensive and all they do is cover over the cash flow problems; they don’t solve them

Question 57

how should a business make its estimates for future cash inflows and outflows

Answer 57

by being pessimistic with the cash inflows (keep them low) and also with the cash outflows (be pessimistic; suspect they will be quite high)