0264 · 5.2.1The importance of cash and cash flow forecasts

Why businesses need cash

0:00Cash is the money a business holds as notes and coins and in its bank account. A business needs enough of it available when payments are due. Customers may have placed plenty of orders, yet their money might arrive after wages must be paid. By the end of this video, you will understand how a forecast reveals that timing problem and helps managers respond. Imagine a small business waiting for customers to settle their bills next month.

0:22Its employees need their wages this week, and the supplier expects payment tomorrow. The owner needs money available now to meet those commitments. Promised payments help with future planning, while cash already available allows the business to pay today. Businesses need cash to pay suppliers, employees, rent and loans on time. Without payment, a supplier may stop deliveries, so the business cannot obtain the materials it needs. Unpaid employees may leave, which interrupts operations.

0:49Meeting these commitments helps the business continue trading and maintains trust with the organisations supporting it. Revenue is the income a business receives from selling goods or services, while profit is total revenue minus total costs. Buying on credit means receiving goods or services now and paying later. A credit sale can generate revenue before the customer’s payment arrives, so a profitable business can still run out of cash and fail.

1:15Profit and cash are therefore different measures.

Cash flow forecasts explained

1:18Cash flow is the cash inflows and cash outflows of a business over a period of time. An estimate of the future cash inflows and outflows of a business, usually month by month, is called a cash flow forecast. It places expected receipts alongside planned payments. Managers can then check whether money will be available when the business needs it. The forecast gives advance warning of months when cash will be short.

1:41Managers can use that warning to arrange borrowing before a payment becomes overdue. Banks may request a forecast before lending because it helps them judge whether repayments are affordable. It also helps owners choose when to spend money on equipment or other large purchases. A forecast depends on estimates, so managers should update it when circumstances change. Customer payments may arrive later than expected, or materials may become more expensive.

2:05Comparing actual receipts and payments with the forecast reveals these changes. An updated forecast gives managers a more useful basis for deciding what to do next. The main features are cash inflow, cash outflow, net cash flow, opening balance and closing balance. Cash inflow is money received by a business during a period. Examples include cash sales, payments from customers who bought on credit, loans received and money invested by owners.

2:32Record each receipt in the month when the money is expected to arrive. Cash outflow is money paid by a business during a period. Wages, materials, rent and loan repayments are examples. Non-current assets are resources owned by a business for use over more than one year. Paying for equipment creates an outflow in the month of purchase, even though the business expects years of use. Net cash flow is cash inflows minus cash outflows.

2:57It shows how much the available money increases or decreases during a period. If receipts exceed payments, the result is positive and adds to the balance. Payments exceeding receipts produce a negative result and reduce the amount available. The opening balance is the cash available at the start of a period. Businesses can use this existing money alongside receipts arriving during the month. The closing balance is the opening balance plus net cash flow.

3:23This calculation combines the starting amount with the increase or decrease during that period. Each month’s closing balance becomes the next month’s opening balance. That connection makes a forecast a continuous account of expected money movements. A change in February can affect the amount available in March. When completing or amending a forecast, follow the balances through every later month.

Worked forecast: Thistle Repairs

3:45Thistle Repairs services bicycles and expects customer receipts to increase over the next few months. Its forecast already contains the expected inflows, outflows and January opening balance. Our task is to fill in the blank cells. Assume all receipts and payments occur in the months shown, and the forecast includes every expected cash movement. Its February payments include three thousand dollars for replacement equipment. January’s cash inflow is four thousand dollars, while its outflow is thirty-five hundred dollars.

4:14The business begins that month with twelve hundred dollars available. February shows receipts of six thousand dollars and payments of eighty-five hundred dollars. March’s expected inflow is eight thousand dollars, with an outflow of five thousand dollars. Net cash flow equals cash inflows minus cash outflows. Four thousand dollars minus thirty-five hundred dollars gives five hundred dollars. Closing balance equals opening balance plus net cash flow. Twelve hundred dollars plus five hundred dollars gives seventeen hundred dollars, which is January’s closing balance.

4:46January’s receipts exceed its payments, so the available money increases during that month. We carry the seventeen hundred dollars forward into February’s opening balance. This transfer preserves the amount remaining from the previous period. February therefore starts with money available before its own customer receipts arrive. Six thousand dollars minus eighty-five hundred dollars gives minus twenty-five hundred dollars for February’s net cash flow. Seventeen hundred dollars plus a net cash flow of minus twenty-five hundred dollars gives a closing balance of minus eight hundred dollars.

5:16Brackets on this forecast indicate a negative value. Read the bracketed eight hundred dollars as minus eight hundred dollars. February’s opening money covers part of the gap between receipts and payments. The remaining shortage is eight hundred dollars by the month’s end. That figure shows the amount of additional cash needed to meet the forecast payments. Unless managers change the timing or arrange finance, the business cannot make every payment as planned.

5:41March opens with minus eight hundred dollars because that was February’s closing balance. Eight thousand dollars minus five thousand dollars gives three thousand dollars for March’s net cash flow. Minus eight hundred dollars plus three thousand dollars gives twenty-two hundred dollars at the end of March. Expected receipts therefore restore a positive closing balance. The red February closing balance identifies the month with a forecast shortage. The three thousand dollar equipment payment helps explain that month’s unusually high outflow.

6:10March’s green closing balance shows that expected receipts later restore available funds. Managers should address February’s payment problem before committing to that equipment purchase. A monthly closing balance gives a useful warning, but managers also need to check payment dates within the month. Wages might fall due before a large customer receipt arrives. Even a positive month-end balance can therefore require careful scheduling. The forecast is most useful when managers connect its totals to the timing of actual commitments.

Amending a cash flow forecast

6:37Now suppose February’s expected cash sales fall by two thousand dollars. These customers would have paid during February, so its forecast inflow falls by the same amount. All other receipts and payments stay unchanged. January remains unaffected because the change occurs after that month has ended. Six thousand dollars minus two thousand dollars gives a revised February inflow of four thousand dollars. Four thousand dollars minus eighty-five hundred dollars gives minus forty-five hundred dollars for net cash flow.

7:06Seventeen hundred dollars plus a net cash flow of minus forty-five hundred dollars gives a closing balance of minus twenty-eight hundred dollars. The forecast shortage has grown from eight hundred dollars to twenty-eight hundred dollars. March’s revised opening balance becomes minus twenty-eight hundred dollars. Its own net cash flow remains three thousand dollars because that month’s receipts and payments are unchanged. Minus twenty-eight hundred dollars plus three thousand dollars gives two hundred dollars for the revised closing balance.

7:33The February change has cut March’s closing balance from twenty-two hundred dollars to two hundred dollars. The amended forecast shows a larger February shortage and a much smaller positive balance in March. Managers now have less room to absorb unexpected payments or late customer receipts. Updating the later balances makes that risk visible. A forecast amendment must include every cell affected by the changed figure.

Responding to cash shortages

7:57A short-term cash flow problem can be addressed through an overdraft, delayed supplier payments, quicker customer receipts or postponed purchases of non-current assets. Each method changes available money or payment timing. Managers should choose a response that fits the cause of the shortage. They must also consider the cost or disruption that the response creates. An overdraft is an arrangement allowing a business to withdraw more money from its bank account than it holds, up to an agreed limit.

8:23Thistle Repairs could use an overdraft to cover February’s shortage of twenty-eight hundred dollars until March’s receipts arrive. Interest is the payment made for borrowing money. Costs rise because the bank charges interest on the amount overdrawn, and it must agree a limit of at least twenty-eight hundred dollars. Delaying supplier payments keeps money available for other immediate commitments. Managers should seek the supplier’s agreement to a later payment date.

8:48The business may lose discounts for prompt payment, which raises its purchasing costs. It may also lose goodwill, so the supplier becomes less willing to offer favourable terms. Asking customers to pay more quickly brings expected receipts forward. A business might send invoices promptly and contact customers before their agreed payment dates. Customers who value time to pay may choose another supplier if terms become less favourable. Managers therefore need to balance faster receipts against the risk of losing future sales.

9:16Delaying the purchase of non-current assets moves a large outflow into a later period. Thistle Repairs could postpone its replacement equipment if the existing machines remain usable. This preserves money for immediate commitments such as wages and rent. The drawback is that growth is postponed, and older machines may break down more often, so the business could complete fewer repairs.

Exam application and recap

9:37When reading a forecast, keep the change during a month separate from the amount available at its end. Net cash flow measures that change, while the closing balance includes money carried forward. Record a credit customer’s payment in the month it is expected to arrive. After an amendment, carry each revised closing balance into the following opening balance. Paper One Short Answer and Data Response and Paper Two Case Study use stimulus information to test understanding.

10:03You may complete missing figures, amend a forecast or explain a suitable response to a shortage. Explain means set out purposes or reasons, say why and how, supported with relevant evidence. This question asks you to connect the equipment payment with February’s available money. Delaying the equipment purchase moves its three thousand dollar payment out of February. February’s outflow then falls from eighty-five hundred dollars to fifty-five hundred dollars. Minus twenty-eight hundred dollars plus three thousand dollars gives a revised February closing balance of two hundred dollars.

10:33The shortage is therefore covered if all other February cash movements stay unchanged. Existing machines must remain usable so that customer work can continue during the delay. Cash is the money a business holds as notes and coins and in its bank account. Remember that cash flow is the cash inflows and cash outflows of a business over a period of time. A cash flow forecast is an estimate of the future cash inflows and outflows of a business, usually month by month.

11:00Its value comes from revealing payment problems early enough for managers to act. Cash inflow is money received by a business during a period, while cash outflow is money paid by a business during a period. To measure the change, net cash flow is cash inflows minus cash outflows. These figures explain whether the amount available rises or falls during the month. The opening balance is the cash available at the start of a period.

11:24For the amount at the end, the closing balance is the opening balance plus net cash flow. Carry that result forward, and update later balances whenever earlier figures change. Choose a response that makes money available when commitments fall due, while considering its costs and effects on trading.