3.7 Cash Flow
• Cash Flow - relates to a business’ inflows and outflows of money which affects liquidity.
• Cash Flow Forecast - a plan of expected inflows and outflows over several time periods such as 3 months
• A company with a profitable product can become bankrupt or illiquid. This is because a profitable product does not necessarily mean
that it has good cash flow
• Cash inflow - is 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. This is also called receipts.
• Cash outflow - is 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 - is the difference between the total cash inflows and cash outflows. It could be positive or negative, and typically
companies aim for a positive net cash outflow figure as it means the company is not facing liquidity problems.
• Opening balance - refers to the amount of cash the firm has in the bank at the beginning of the month.
• Closing balance - the amount of cash that the company has at the end of the month. It becomes the opening balance for the next
month.
• Closing Balance = opening balance + net cash flow for the month
Reasons for poor cash flow: Increasing Cash Flow:
• Lengthy credit period and poor credit collection • Effective debt collection
• some goods may be purchased on credit, longer credit terms • ensure money owned is paid in time by frequently
affect cash inflows which impacts the net cash flow position of reminding customers via phone calls or emails or do credit
the business. A low creditor days ratio is desirable checks prior to purchase
• Overstocking • Cash transactions only
• The company could hold too much stock and tie up most of its • no credit involved as cash is an immediate means of
money in it. exchange, however some loyal customers may be lost
• Poor pricing strategy who can only pay via credit
• penetrating the market with low prices can result in inadequate • Increased promotion
cash inflows • increase sales through various methods of promotion,
• High expenses however increased promotion increases outflows so cash
• if outflows are larger than inflows a negative net cash flow is flow may only increase marginally
produced • expanding product portfolio
• Overtrading • diversifies risk and introduces a new revenue stream but
• occurs when business tried to expand too rapidly than what the introducing a new product involves large outflows
funds support which causes a constant cash shortfall • Better stock management
• Low sales • use a just-in-time system to reduce the amount of cash
• due the business being new or having poor promotion tied up in stock
• Seasonal demand • Renegotiate credit terms
• seasonal products like ice cream have low sales in winter when • try to negotiate increased debtor days compared to
not in season creditor days
• Switch to cheaper suppliers
• reduces costs but could affect quality of end products
• Reduce expenses
The Working Capital Cycle:
• cut unnecessary expenses like staff parties or use fuel
more resourcefully, but this could affects productivity and
• the funds in the business for motivation
its day-today operations
• Leasing rather than purchase of equipment
• Current Assets - Current • leasing requires small monthly payments compared to the
Liabilities large lump sums to pay for the purchase of equipment
• Finding alternative sources of finance
• overdrafts can be arranged with provider easily if business
has dealt with them for a long time, the disadvantage is
Limitations of Cash Flow:
interest
• Sale of fixed assets
• Competitors
• improve liquidity is the fixed assets sold are not used
• competition to maximise sales to increase market share, a
• Government assistance
competitors increase in sales may decrease the business’
• the government can provide grants and subsidiaries to
inflows
companies that provide essential goods and services or
• Changes in economy provide employment in areas with high unemployment
• a recession or severe inflation could reduce inflows. A rise in
• Debt factoring
exchange rates, interest rates or taxes would reduce demand
• The sale of debt to a debt factoring company for a
for goods and services. A boom would have the opposite effect.
reduced price of the original debt to pay it off quickly
• External shocks
• changes in international economy and natural disasters could
increase outflows
• Poor marketing Profit, Investment and Cash Flow
• could result in lower than expected sales which reduces inflows
• Human resource challenges • profit is a comparison of income, production costs and
• poor communication or demotivated workers could be less expenses. Profit = Sales Revenue - Total Costs
productive and reduce output, which inhibits possible sales • Cash flow is the actual movement of the money. Net Cash
• Plant and equipment breakdown Flow = Cash Inflow - Cash Outflow
• breakdowns could slow production which affects sales revenue • Investment is the purchase of an asset (an outflow)
• Cash Flow - relates to a business’ inflows and outflows of money which affects liquidity.
• Cash Flow Forecast - a plan of expected inflows and outflows over several time periods such as 3 months
• A company with a profitable product can become bankrupt or illiquid. This is because a profitable product does not necessarily mean
that it has good cash flow
• Cash inflow - is 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. This is also called receipts.
• Cash outflow - is 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 - is the difference between the total cash inflows and cash outflows. It could be positive or negative, and typically
companies aim for a positive net cash outflow figure as it means the company is not facing liquidity problems.
• Opening balance - refers to the amount of cash the firm has in the bank at the beginning of the month.
• Closing balance - the amount of cash that the company has at the end of the month. It becomes the opening balance for the next
month.
• Closing Balance = opening balance + net cash flow for the month
Reasons for poor cash flow: Increasing Cash Flow:
• Lengthy credit period and poor credit collection • Effective debt collection
• some goods may be purchased on credit, longer credit terms • ensure money owned is paid in time by frequently
affect cash inflows which impacts the net cash flow position of reminding customers via phone calls or emails or do credit
the business. A low creditor days ratio is desirable checks prior to purchase
• Overstocking • Cash transactions only
• The company could hold too much stock and tie up most of its • no credit involved as cash is an immediate means of
money in it. exchange, however some loyal customers may be lost
• Poor pricing strategy who can only pay via credit
• penetrating the market with low prices can result in inadequate • Increased promotion
cash inflows • increase sales through various methods of promotion,
• High expenses however increased promotion increases outflows so cash
• if outflows are larger than inflows a negative net cash flow is flow may only increase marginally
produced • expanding product portfolio
• Overtrading • diversifies risk and introduces a new revenue stream but
• occurs when business tried to expand too rapidly than what the introducing a new product involves large outflows
funds support which causes a constant cash shortfall • Better stock management
• Low sales • use a just-in-time system to reduce the amount of cash
• due the business being new or having poor promotion tied up in stock
• Seasonal demand • Renegotiate credit terms
• seasonal products like ice cream have low sales in winter when • try to negotiate increased debtor days compared to
not in season creditor days
• Switch to cheaper suppliers
• reduces costs but could affect quality of end products
• Reduce expenses
The Working Capital Cycle:
• cut unnecessary expenses like staff parties or use fuel
more resourcefully, but this could affects productivity and
• the funds in the business for motivation
its day-today operations
• Leasing rather than purchase of equipment
• Current Assets - Current • leasing requires small monthly payments compared to the
Liabilities large lump sums to pay for the purchase of equipment
• Finding alternative sources of finance
• overdrafts can be arranged with provider easily if business
has dealt with them for a long time, the disadvantage is
Limitations of Cash Flow:
interest
• Sale of fixed assets
• Competitors
• improve liquidity is the fixed assets sold are not used
• competition to maximise sales to increase market share, a
• Government assistance
competitors increase in sales may decrease the business’
• the government can provide grants and subsidiaries to
inflows
companies that provide essential goods and services or
• Changes in economy provide employment in areas with high unemployment
• a recession or severe inflation could reduce inflows. A rise in
• Debt factoring
exchange rates, interest rates or taxes would reduce demand
• The sale of debt to a debt factoring company for a
for goods and services. A boom would have the opposite effect.
reduced price of the original debt to pay it off quickly
• External shocks
• changes in international economy and natural disasters could
increase outflows
• Poor marketing Profit, Investment and Cash Flow
• could result in lower than expected sales which reduces inflows
• Human resource challenges • profit is a comparison of income, production costs and
• poor communication or demotivated workers could be less expenses. Profit = Sales Revenue - Total Costs
productive and reduce output, which inhibits possible sales • Cash flow is the actual movement of the money. Net Cash
• Plant and equipment breakdown Flow = Cash Inflow - Cash Outflow
• breakdowns could slow production which affects sales revenue • Investment is the purchase of an asset (an outflow)
