Cash Flow forecast
Ronnie produces a cash flow forecast to determine what money he will have coming in and what money he will need to pay out. If he does not do this, he may run out of money and struggle to perform as a business thus he may even face bankruptcy. From his cash flow forecast Ronnie can decide whether he needs to borrow money from the bank to keep his cash flowing in the business. When Ronnie produces these predictions called a cash flow forecast he can use them to make management decisions. These decisions could take the form of: 1. Whether he should produce a new product or service, what are the likely costs and income from his new venture. 2. Whether he should invest in buying new equipment. What income he may receive if he decides to buy a new photocopier. Will the new photocopier reduce his overall costs because it is breaking down less and there is less time wasted in preparing the old one. 3. Whether he should open a new branch or employ another member of staff. What incomes will he gain by having a new shop, which may attract new business, and what costs will the new shop incur. If he employs a new member of staff this will mean better productivity but what will be the costs of employing someone else. Inflows – are classed as money coming into Ronnie’s business Outflows – are classed as money leaving Ronnie’s business. Here is a list of items which either are inflows or outflows for Ronnie. You decide and place them in the table format below. Inflows – money coming in Outflows – money going out
Sale of goods Payment made to other companies to pay for raw materials Bank loan Rent and rates Grant from government Employees wages Fund of money give by European Grant Payment for Ronnie to advertise in the local press and promoting his goods Payment for Taxes to Inland Revenue Capital ie money invested from shareholders etc. Payments for running costs
ANSWER Where the money comes from inflows Sales of goods/service Capital ie money invested from the owners ie shareholders, personal savings Bank loans ie overdrafts Grant and other incomes ie local authorities or European funds Where the money goes to - outflows Payments to suppliers ie raw materials, equipment Rent and rates Employees wages Payments for running costs Advertising and promotion Taxes and national insurance ie government
Ronnie’s cash flow forecast enables him to see when money is expected to be received and paid out within the business so that if at any time insufficient money is coming in to cover payments due, appropriate action can be taken ie short term loan/overdraft. If the cash flow is not completed accurately decisions based on this incorrect information may create problems for employees, customers, suppliers, providers of finance and the owners ie money may be borrowed from a lender when it is not needed.
Calculating the Opening bank balance and the closing bank balance of a cash flow forecast.
The closing bank balance shows how much money is in the bank at the end of a given period. REMEMBER Money in the bank and profit are not the same. It must be remembered that some goods have a credit period ie there is a time gap between buying the products and having to pay for them. In these cases you must take care to enter the inflows or outflows only when the money is paid out to suppliers or due to be received from customers.
Here is an example of the layout of Ronnie’s Cash Flow forecast:
Cash Flow Forecast for Ronnie between January and May of 2003.
January February March April May
Inflows
Sales Loans received Capital Grant Total inflows (A)
Outflows
Raw materials Wages/salaries Rent and rates Electricity Stationery Telephone Advertising/marketing Mailing New equipment Insurance Loan repayment Total of outflows (B) Net cash flow (A-B) = (C) Opening balance (D) Net Cash flow (C) Closing balance (E) Complete the table with the following information below: Opening balance of: nil January February March Sales 30,000 45,000 46,000 Loans received 5,000 nil nil Capital 10,000 nil nil Grant 5,000 nil nil Raw materials 30,000 30,000 30,000 Wages/salaries 22,000 12,000 12,000 Rent and rates 1,000 1,000 800 Electricity 100 100 100 Stationery 100 50 50 Telephone 100 100 100 Advertising/marketing 300 nil nil Mailing 50 50 50 New equipment 1,000 nil nil Insurance 50 50 50 Loan repayment 100 100 100
April 50,000 Nil Nil Nil 30,000 12,000 800 100 50 100 nil 50 nil 50 100
May 48,000 Nil Nil Nil 28,000 12,000 800 100 50 100 300 50 nil 50 100
Answer Cash Flow Forecast for Ronnie between January and May of 2003.
January February 45,000 nil nil nil 45,000 30,000 12,000 1,000 100 50 100 nil 50 nil 50 100 43,450 1,550 (4,800) 1,550 (3,250) March 46,000 nil nil nil 46,000 30,000 12,000 800 100 50 100 nil 50 nil 50 100 43,250 2,750 (3,250) 2,750 (500) April 50,000 Nil Nil Nil 50,000 30,000 12,000 800 100 50 100 nil 50 nil 50 100 43,250 6,750 (500) 6,750 6,250 May 48,000 Nil Nil nil 48,000 28,000 12,000 800 100 50 100 300 50 nil 50 100 41,550 6,450 6,250 6,450 12,700
Inflows
Sales Loans received Capital Grant Total inflows (A) 30,000 5,000 10,000 5,000 50,000
Outflows
Raw materials 30,000 Wages/salaries 22,000 Rent and rates 1,000 Electricity 100 Stationery 100 Telephone 100 Advertising/marketing 300 Mailing 50 New equipment 1,000 Insurance 50 Loan repayment 100 Total of outflows (B) 54,800 Net cash flow (A-B) = (4,800) (C) Opening balance (D) nil Net Cash flow (C) (4,800) Closing balance (E) (4,800)
Questions that you should be able to answer: 1. Explain the importance to a business of using a cash flow forecast? Answer Cash flow forecast help predict areas of profit and loss without them businesses would have no idea of impending losses. Enables the company to predict into the future adjusting the businesses financial plans. Shows the money, which will be actually paid and received and allows planning of income and expenditure. Allows the business to make a best guess for the future activities of the company Enables the business to adjust their working practices if they can see a problem looming, such as negative cash flow for a month or two (this is when the business is spending more than it is earning) The bank may agree a business loan for a short period based on the cash flow forecast. Cash flow forecast can identify whether the business needs financial help before it starts trading. Enable the business to track its financial transactions Enables the business to make sure records are kept for tax purposes. Enables the business to decide whether it is solvent or insolvent. Solvent – has enough cash for day to day running of the business. Insolvent – business does not have enough cash for day to day running of the business. 2 Analyse February forecast and explain why February is showing a positive cash flow for the month? Answer In February the business must have lost one of its workers as the wage bill has decreased by approximately £10,000 and the business had little income other than sales for the month. The business seems to have made savings on the cost of raw materials this could be the result of changing to a more competitively priced supplier or ordering less raw materials. Sales have increased by £15,000 this could be due to the advertising and promotional campaign in January. The purchase of new equipment in January could have increased the sales in February. 2 What decisions can management make as a result of producing a cash flow forecast?
Answer: a. Help a business decide whether to proceed with producing a new product. b. Help a business decide whether it needs to purchase new resources for example, improved technology. This will initially increase expenditure but in the long run as the business becomes more productive then
direct and indirect costs may fall and productivity and quality should improve. This measure should lead in the long run to an improved cash flow. c. Helps the business decide whether it should carry out a new activity. d. Helps a business decide whether it should expand or reduce its existing activities. 3 Explain the ways a business can: (a) increase cash flow into a business (b) reduce the cash flow out of a business.
Answer 3 (a) increase cash flow into a business reduce the selling price of the goods/services being sold. This will mean that sales should increase and, therefore, the inflow of cash should increase do not allow customers extended credit opportunities. This may mean selling more cash items or expecting customers to pay their outstanding debts quickly. Often business will offer a discount if customers pay their debts within a certain period of time. provide a system in the business which chases any customers who have outstanding debts. Introduce new which hopefully will increase sales revenue. 4 (b) reduce the cash flow out of a business. Purchase improved equipment on the production line and use technology to improve productivity and quality within the business. This will increase cash outflow in the short run but in the long run will increase income into the business Look at using different suppliers who are more cost effective or cutting down on wastage within the business, thus improving quality. Offer a variety of different methods of paying for the goods/services provided by the business . Trying to cut down on overheads in the business ie looking for suggestions from employees to trim overhead expenses.
Double Award Applied Business Finance exam – Specimen paper OCR board. Tackle question 11, 12, 13, (possible 14) and 15. Alternatively , see AQA Specimen paper Double Award Business finance paper Question 3a 3b 3c 3d Activities Students could be divided into groups using Ronnie’s cash flow forecast and present their findings to changes in the cash flow forecast.
Changes could include: Purchase of new equipment Dramatic decrease in sales Increase in the cost of raw materials Should he expand into a new activity.
Cash Flow Forecasts using a computer spreadsheet
Benefits of using a computer spreadsheet: If you want to change a figure it will amend other areas of the spreadsheet automatically You can change start up costs easily You can change running costs easily Calculations can be done with little effort and for large amounts Can be set up to look at numeric data No errors in calculations provided the formulae and the numbers have been inputted correctly. Accurate financial picture so the business can identify problems with the cash flow quickly Can get graphs, bar charts etc from the spreadsheet. These can be used to identify patterns or trends in the figures. Each spreadsheet can be cut and pasted into other packages for ease of use ie a word document to form part of a monthly report - even PowerPoint presentations. Disadvantages Difficult to print out on one sheet of A4 A mistake can cause big problems, which can be replicated throughout the spreadsheet. No facility to explain cells Spreadsheet may be difficult to understand Poor users have difficulty doing spreadsheet particularly the formula. Errors can be made if you enter a cell incorrectly. If you change data on a spreadsheet you should keep the original spreadsheet just in case. Copying formula can be difficult with some formula. Spreadsheets take a great deal of time to set up and need to be set up by someone who understands how data is inputted into the spreadsheet ie absolute and relative references. Spreadsheets can be lost if saved incorrectly or the file is corrupt. Spreadsheet designers and operators should always save their work and back it up.