Using Cash Flow Forecasts aqa

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Exam code:8132

Completing and interpreting cash flow forecasts

A business must first gather information about all cash inflows and cash outflows it expects to encounter over the period
The following steps should then be taken to construct the cash flow forecast

In this instance, the business expects to receive cash inflows from sales in March, April and May
Owners’ capital of €6,000 will be introduced in March
The total for each month is calculated by adding cash from sales to capital introduced

In this instance, the business expects to pay rent of €1,400 in March, April and May
It will purchase a significant amount of stock in March, with smaller amounts in April and May
Wages are expected to be €2,100 in each month
Utilities of €460 will be paid in March and April, increasing to €480 in May
Total cash outflows each month is calculated by adding these together

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

In March the net cash flow is €10,500 – €10,760 = €(260)
- Net cash flow is negative as cash outflows are greater than cash inflows
In April the net cash flow is €4,800 – €4,560 = €240
In May the net cash flow is €5,300 – €4,780 = €520
- In both months, net cash flow is positive as cash inflows are greater than cash outflows

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

In March the opening balance of €0 is added to the net cash flow of €(260) to leave a closing balance of €(260)
In April the closing balance from March is carried forward to become its opening balance of €(260)
This opening balance is added to April’s net cash flow of €240 to leave a closing balance of €(20)
In May the closing balance from April is carried forward to become its opening balance of €(20)
This opening balance is added to May’s net cash flow of €520 to leave a closing balance of €500

Overall, this cash flow forecast shows low cash inflows and significant outflows initially, which lead to negative net cash flow in March and April
Healthy sales mean that from April, inflows are greater than outflows and the business has a positive net cash flow

The cash flow forecast example above identifies a cash flow problem in March and April where the closing balance is negative
It has a range of ways to solve this issue to prevent insolvency
- The most suitable method may be to arrange a flexible, short-term overdraft facility with its bank

Method	Explanation
Reduce the credit period offered to customers	Collecting money owed from customers more quickly will increase the level of current assets in the business However, customers may move to competing businesses that offer better credit terms
Ask suppliers for an extended repayment period, e.g an extension from 60 to 90 days	Current liabilities will not be reduced The business can use cash it would have paid to suppliers for other purposes Suppliers may be unwilling to extend credit terms
Make use of overdraft facilities or short-term loans	Current liabilities will increase The business can spend more money than it has in its bank account Banks may be reluctant to lend to businesses with cash-flow problems
Sell off excess stock	Less liquid current assets will be reduced and converted into more liquid forms of current asset (e.g. cash) Stora