Forecasting and managing cash flow

Last time

Before we start: last time, in Costs, break-even analysis and budgets, you learned these points. Here they are again on one card. Keep them in mind, because today builds on them.

Cash keeps the business alive

Profitable businesses can still fail if they run out of cash. Cash flow forecasts warn of shortages in advance, and managers have several ways to improve cash flow. This lesson covers both.

Cash flow forecasts

A cash flow forecast estimates cash inflows and outflows for each future month. Net cash flow is inflows minus outflows. Opening balance plus net cash flow gives the closing balance, which becomes next month's opening balance. With an opening balance of 2,000, inflows of 10,000 and outflows of 11,500, the closing balance is 500.

Uses and limits of forecasts

Forecasts show when cash will be short, support loan applications, and help plan spending. But they depend on estimates of sales and costs, which may be wrong, especially for new businesses. So they should be updated regularly.

Causes of cash flow problems

Giving customers long credit periods while paying suppliers quickly. Overtrading: expanding too quickly without enough working capital. Holding too much inventory, seasonal sales, and unexpected costs.

Improving cash inflows

Debt factoring: selling receivables for immediate cash, at a discount. Shorter credit terms for customers, or discounts for early payment. Sale and leaseback of assets, or selling surplus inventory.

Reducing cash outflows

Negotiate longer credit from suppliers. Delay capital spending, lease rather than buy, and cut unnecessary costs. Each method has a cost: lost discounts, strained supplier relations, or missed opportunities.

Choosing a method

Debt factoring brings cash quickly but costs a share of the receivables, and customers may dislike dealing with a factor. Shorter credit terms improve inflows but may lose customers to rivals offering better terms. The best method depends on the cause of the problem and how quickly cash is needed.

A forecast, worked

One month of a cash flow forecast, worked through.

Cash flow and profit

Profit is revenue minus costs over a period; cash flow is the timing of money in and out. Credit sales raise profit before cash arrives; buying equipment uses cash but is not all a cost this year. So a business must manage both.

Mistakes that lose marks

Mistake one: confusing cash flow with profit. Mistake two: forgetting to carry the closing balance forward. Mistake three: suggesting a method without its drawback. The fix: careful working, and each method weighed.

The full-marks tip

The full-marks tip: work the forecast month by month: opening plus inflows minus outflows. For each improvement method, give its benefit and its cost for this business.

On one card

So, on one card: cash flow. Keep it for revision.