The Importance of Cash & Cash Flow Forecasts

Why cash is important

Why is cash important?

• Cash is the 'blood' of a business, as without it, a business cannot survive

  • It is a liquid asset in the form of notes, coins and money in the bank

• A new business may have to pay cash on purchase for all of its supplies until its suppliers trust them enough to grant trade credit

  • A supplier may then give the business 30 or 60 days to pay for items they purchase

  • This means that the business can receive their stock now pay for it later, so the cash outflow is delayed

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

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

• More established businesses need to ensure that they manage cash effectively to ensure that they do not run out of money

  • Cash-flow issues may put the business in a situation where it is :

    • Unable to pay key stakeholders, such as workers and suppliers

      • Production is likely to cease, as workers will not work without pay and suppliers will not supply goods if they are not paid

    • Unable to pay utility bills and rent

  • As a result, the business could be forced into liquidation and is, ultimately, likely to fail

Introduction to cash flow forecasts

Introduction to cash flow forecasts

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

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

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

Features of cash flow forecasts

Features of cash flow forecasts

Cash inflows

• Cash inflows are sums of money coming into the business

• This includes items like sales revenue, loans received or money from investors

Cash outflows

• Cash outflows are sums of money leaving the business

• This includes payments for rent, wages, stock, bills or loan repayments

Net cash flow

• Net cash flow is the difference between cash inflows and cash outflows in a given period

  • If net cash flow is positive, the business has more cash coming in than going out

  • If it's negative, the business is spending more than it receives

• Net cash flow is calculated using the formula

$\mathrm{Net} \mathrm{cash} \mathrm{flow} = \mathrm{Cash} \mathrm{inflows} - \mathrm{Cash} \mathrm{outflows}$

Opening balance

• The opening balance is the amount of cash the business has at the start of a period, e.g., the beginning of the month

• It is usually the same as the closing balance from the previous period

Closing balance

• The closing balance is the amount of cash the business has at the end of the period

  • This figure shows whether the business will have enough money at the end of the month to cover its needs

• The closing balance is calculated using the formula

$\mathrm{Closing} \mathrm{balance} = \mathrm{Opening} \mathrm{balance} + \mathrm{Net} \mathrm{cash} \mathrm{flow}$