Introduction - the importance of cash flow

• Liquidation: when a firm ceases trading and its assets are sold for cash.

• Insolvent: when a business cannot meet its short-term debts.

• Net cash flow: sum of cash payments to a business (inflows) less the sum of cash payments made by it (outflows).

Cash and profit

• Cash outflows: payments in cash made by a business, such as those to suppliers and workers.

• Cash inflows: payments in cash received by a business, such as those from customers (debtors) or from the bank, e.g. receiving a loan.

Working capital

• Where does working capital come from?

  • Working capital = Current assets - Current liabilities

    • Current assets: stocks, debtors (= customers who have bought products on credit and will pay cash at an agreed date in the future) and cash.

    • Current liabilities: debts of the business that will usually have to be paid within one year.

• How much is needed?

  • The working capital requirement for any business will depend upon the “length” of this “working capital cycle” which is the period of time between spending cash on the production process and receiving cash payments from customers.

Cash flow forecasts

• Forecasting cash inflows

  • Owners’ own capital injection

  • Bank loan payments easy to forecast

  • Customers’ cash purchases

  • Debtors’ payments difficult

• Forecasting cash outflows

  • Lease payment for premises

  • Annual rent payment

  • Electricity, gas, water and telephone bills

  • Labor cost payments

  • Variable cost payments such as cleaning materials

• Structure of cash flow forecasts

  1. Cash inflows

  2. Cash outflows

  3. Net monthly cash flow and opening and closing balance

Causes of cash flow problems

• Lack of planning

• Poor credit control

• Allowing customers too much credit

• Expanding too rapidly

• Unexpected events

Strategies for dealing with cash flow problems

• Reducing cash outflows

• Improving cash inflows

• Sourcing additional finance