1-3-5-Cash-And-Cash-Flow-Forecasts

The importance of cash to a business

• Profit and cash are different financial concepts

  • Profit is simply the difference between sales revenue generated and business costs

  • Cash is measured by taking into account the full range of money flowing in and out of a business

• A new business may have to pay cash on purchase for all of its supplies until its suppliers trust them enough to provide credit terms (buy now, pay later)

  • A supplier may then give the business trade credit of 30 or 60 days

  • This means that the business can receive their stock now and only pay for it in 30 or 60 days – the cash outflow is delayed

  • As the business sells its products, they receive money generated from the business revenue and this represents a cash inflow

  • At the end of 60 days they will pay their supplier (cash outflow), but the firm may still have half of its stock available for sale

• A profitable business is likely to fail if it does not have sufficient cash

  • Cash-poor businesses will struggle to pay suppliers, employees and operating expenses

  • This is called insolvency 

    • E.g. Lifestyle retailer Joules announced plans to liquidate in December 2022 as a result of cash flow difficulties despite making a profit of £2.6 million during the previous year

Calculation and interpretation of cash-flow forecasts

• A cash-flow forecast is a prediction of the anticipated cash inflows and cash outflows, typically for a three, six or twelve month period

  • Typical outflows include payments on raw materials, paying staff wages and salaries, paying bills such as electricity

  • Typical inflows include receipts from sales, money received from a new bank loan, money from the sale of an asset

Key terminology and an example

• The net cash flow is calculated by subtracting total outflows from total inflows

• The opening balance is the previous month’s closing balance carried forward

• The closing balance is calculated by adding the net cash flow to the opening balance

An example of a start-up 3 month cash-flow forecast

Analysis of the cash-flow forecast example

Summary

• Overall, this cash-flow forecast supports a decision for the business to arrange an overdraft facility with their bank

• As sales increase in January and February, inflows are greater than outflows and the business has a positive cash flow

• This changes in March as the level of sales falls and the net cash flow turns negative

• An overdraft facility will help them survive if their closing balance drops below zero in the next month or two

January

• The opening balance of £500 has been introduced by the owner

• The business is expected to achieve sales of £4,600

• Total outflows are expected to be £4,540

• The Net Cash Flow is expected to be £60 (£4,600 – £4,540)

• January’s closing balance is expected to be £560(£60 + £500)

February

• The closing balance from January becomes the opening balance for February

• Sales of £5,100 are expected to be the business total inflows 

• Total outflows are expected to be £3,890

• The net cash flow is expected to be £1,210 (£5,100 – £3,890) 

• The closing balance is expected to be £1,770 (£1,210 + £560) 

March

• The closing balance from February becomes the opening balance for March

• The business expects to achieve sales of £3,100 as its total inflows 

• Total outflows are expected to be £3,940

• The net cash flow is expected to be -£840 (£3,100 – £3,940) 

• The closing balance is expected to be £930 (-£840 + £1,770)