3.7 Cash Flow
Categories in a Cash Flow Statement
**For IB. This is NOT how they look in other classes....- Receipts: These are all inflows the business organization receives. Essentially, receipts are any positive contribution towards the cash position of the business. Therefore, revenue from ticket sales or any type of sale, loans from banks and collection of unpaid debts would fall under this category. The Total Receipts will be the accumulated value of the Receipts.
- Payments: These are all the outflows from the business organization. Payments reduce the liquidity of the business but are a necessary element of operation. Most of the payments are expense items such as salaries, rent, electricity payments or loan repayments. The Total Payments will be the accumulated value of all the Payments.
- Net Cash Flow: This is the difference between the Receipts and Payments and is calculated as follows: Total Receipts – Total payments = Net Cash Flow. The Net Cash Flow represents how much cash has been retained after all payments have been paid in the period.
- Opening Balance: The Opening Balance is the value that has been carried forward from the prior period. This can be a positive of negative number. The Opening Balance is therefore the ongoing record of the cash position of the business.
- Closing Balance: The difference between the Net Cash Flow and the Opening Balance is the Closing Balance calculated as follows: Sum of Net Cash Flow and Opening Balance = Closing Balance
Survival Strategies in Liquidity Crisis
In order to make sure that business organizations do not experience negative cash flows a business must have strategies in place when there is a liquidity crisis. This could include
· the negotiation of short-term bridge loans
· offering discounts on products or services being sold
· requesting the extension of credit from suppliers or lenders beyond the usual repayment periods
· making adjustments to purchases and all other payments
· selling non-critical assets in order to raise the cash needed
Reasons why firms have working capital problems
Credit Control - firm does a bad job in deciding when a customer should have trade credit and how much trade credit they get. If not careful enough then the firm will starthaving bad debt (customer doesn't pay). One reason why some this is especially difficult that without the customer receiving trade credit, they may not purchase the goods and the firm loses out on a sale.
Collections - firm doesn't chase up debtors to pay their outstanding debts.
Overtrading - firm tries to grow too quickly.
Overstocking - firm keeps too much stock (inventory). Though stock is a current asset, just sitting on the shelf does not generate any money for the firm. Also, excess stock requires storage which costs money.
Seasonality - certain products have great demand swings depending on the time of year. For example, Christmas trees only happen to be popular right before Christmas. A firm may need to buy a huge amount of trees to have enough to meet the demand of their customers. Do they have enough cash to buy the trees?
