3.

7 CASH FLOW
CASH VS PROFIT

 Cash is a current asset. It is essential for the functioning of a business.

 Money from the sale of goods and services.
 It can be either held 'in hand' (actual cash in the business) or 'at bank' (cash held in
a bank account).

 Profit is the positive difference between a firm's total sales revenue and its total
costs of production
 When a firm sells its product in credits, profit is made before the cash is received
 Therefore, it is possible for a firm to be profitable but cash deficient. Conversely, it
is also possible to be cash rich but unprofitable.
THE WORKING CAPITAL CYCLE

 Working capital refers to the cash or liquid assets available for the daily running of
a business.
 A lack of working capital means that the firm has insufficient cash to fund its
routine operations.
 The term liquidity refers o how easily an asset can be turned into cash
 Highly liquid assets are those that can be converted into cash quickly and easily
without losing their monetary value, e.g. cash deposits at a bank.
CURRENT ASSETS
CURRENT LIABILITIES
THE CYCLE

 For most businesses, there is a delay between paying for costs of production (such
as the purchase of stock and payment of wages) and receiving the cash from
selling their products.
CASH FLOW FORECASTS

 A cash flow forecast is a financial document that shows the expected movement
of cash into and out of a business, per time period

 Cash inflows usually come from sales revenue when customers pay for the
products that they have purchased.
 Cash outflows refers to cash that leaves a business, e.g. when invoices or bills
have to be paid.
 Net cash flow refers to the difference between cash inflows and cash outflows,
per time period.
REASONS FOR CASH FLOW FORECASTS

 Banks need it to assess the financial health of the business seeking external
finance

 Managers use it to anticipate and identify periods of potential liquidity problems

 Forecasts can be compared with actual cash flows to improve future predictions
and planning.  Aid business planning
CONSTRUCTING CASH FLOW FORECAST
CAUSES OF CASH FLOW PROBLEM

 Overtrading
 This situation occurs when a business attempts to expand too quickly
 Over borrowing
 During times of rising interest rates, cash outflow on loan interest increases, putting further
pressure on a firm's working capital and liquidity position.
 Overstocking
 When a business holds too much stock as a result of an ineffective stock control system
 Poor credit control
 Problems arise when a firm offers customers an extended credit period, leading the business to
trade for long periods without cash inflows.
 Unforeseen changes
 Machinery breakdown, seasonal flunctuations, etc
INVESTMENT, PROFIT, CASHFLOW

 Examples of how investment, profit and cash flow are interlinked include:

• When a business sells an investment, it experiences an increase in its cash flow

position. The opposite happens when a business buys an investment.

• When a firm obtains finance for investments, the cash inflow improves its liquidity
position.
STRATEGIES FOR CASH FLOW PROBLEMS

 Reducing cash outflows

 Improving cash inflows
 •Seeking alternative sources of financ
REDUCING CASH OUTFLOW

 Seek preferential credit terms

 Seek alternative suppliers
 Better stock controls
 Reduce expenses
 Leasing
 Change policy pricing
 Improved product portfolio
IMPROVING CASH FLOW

 Tighter credit control:

 Firms can limit trade credit to their customers or reduce the credit period.

 Cash payments only:

 Requiring customers to pay by cash only removes the delay in receiving cash from
credit sales.
SEEKING ALTERNATIVE SOURCE OF FINANCE

 Overdrafts
 Selling fixed assets
 Debt factoring
 Government assistance
LIMITATIONS

 Inaccuracies can occur due to a number of reasons, such as:

 Marketing
 Human resources
 Operation management
 Competitors
 Changing fashion and taste
 Economic change
 External shocks