Lesson aims

• Distinguish between profit and cash flow
• Explain the working capital cycle
• Construct and interpret cash-flow forecasts
• Evaluate possible strategies for dealing with cash flow problems

Cash flow

• This is the money that flows in and out of a business over a given period of time.
• Insolvency - If a business is is profitable but has little or no cash.

Reasons for poor cash flow

• Lengthy credit period and poor credit collection
• Overstocking
• Poor pricing strategy
• High expenses
• Overtrading
• Low sales
• Seasonal demand

Working capital cycle

• Working capital - the money needed to pay for the day-to-day running cost of a business.
• Working capital cycle - the period of time between payment for goods supplied to a business and the business receiving cash from their sale.

Cash flow forecasts

• These are future predictions of a firm's cash inflows and outflows over a given period of time.

Constructing cash flow forecasts

• Opening balance - the amount of cash the firm has in the bank at the beginning of the month.
• Cash inflow (receipts) - the amount of cash flowing into or earned by the business from sales, debtors and other non-core activities such as the sale of unused fixed assets or the rental of extra office space.
• Cash outflow - the amount of cash paid out by the business for core operations such as raw materials, creditors and electricity and other activities such as legal fees.
• Net cash flow - the difference between the total cash inflows and cash outflows.
• Closing balance - the amount of cash that the company has at the end of the month.

Strategies to deal with cash flow problems

Increasing cash inflows

• Effective debt collection
• Cash transactions only
• Increased promotion
• Expanding product portfolio

Reducing cash outflow

• Better stock management
• Renegotiate credit terms
• Switch to cheaper suppliers
• Reduce expenses
• Leasing rather than purchase of equipment

Finding other sources of finance

• Overdrafts
• Sale of fixed assets
• Government assistance
• Debt factoring

Limitations of cash flow forecasting

• Difficulty in predicting competitors' behaviour
• Unexpected changes in the economy
• External shocks
• Poor marketing research and associated poor marketing strategy
• Human resource challenges (e.g. demotivated employees)
• Unforeseen plant or equipment breakdown