Using Cash Flow Forecasts (AQA GCSE Business)

Revision Note

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Completing & 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

Step 1: Calculate total cash inflows

Cash inflows include cash from sales and capital introduced

Explanation

  • 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

Step 2: Calculate total cash outflows

Cash outflows include rent, stock purchases, wages and utilities

Explanation

  • 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

Step 3: Calculate net cash flows

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

Net cash flow is calculated by subtracting cash outflows from cash inflows

Explanation

  • 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

Step 4: Calculate opening and closing balances

  • 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

The opening balance is provided, while closing balance is calculated by adding net cash flow to opening balance

Explanation

  • 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

Diagram: A complete cash flow forecast

The complete cash flow forecast shows monthly cash inflows, outflows, net cash flow, opening and closing balances

Cash flow forecast analysis

  • 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

Solutions to Cash Flow Problems

  • 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

Ways to solve cash flow problems

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)

  • Storage and security costs may also be reduced

  • Stock may need to be sold at a low price to attract sales

Sell assets and lease fixed assets instead (e.g. sale & leaseback)

  • Both current assets and current liabilities will increase

  • The business will continue to have the use of assets but must make regular payments to the leasing company

Introduce new capital and reduce drawings from the business

  • Current assets will be increased

  • New capital may be introduced by the owner or from additional investors

  • This may result in a dilution of control over the business

Examiner Tip

A common misconception is that cash flow issues are only focused on a business not having enough cash. However, a business can also have too much cash

  • If it holds large amounts of cash, it may miss out on the benefits of investing it in fixed assets or savings

  • This may represent a significant opportunity cost especially when interest rates are high

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