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Cash flow and cash flow forecasts

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Lesson notes

Cash and profit

  • Profit measures revenue minus the relevant costs over a period; cash flow measures receipts and payments. Liquidity concerns meeting short-term payment obligations when they fall due. Money owed by customers, stock and accounting profit are not automatically spendable cash.
  • Fictional timing example: a £1,000 January credit sale has £600 related costs paid in January, and the customer pays in February. With no other transactions, January profit is £400 and January net cash flow is −£600. The February £1,000 collection is not new sales revenue.

A credit sale is not a cash receipt

A credit sale is not a cash receiptFictional itemJanuaryFebruarySales revenue£1,000£0Related costs recorded£600£0Profit£400£0Customer cash received£0£1,000Cash costs paid£600£0Net cash flow−£600£1,000

Cash flow

  • Inflows include customer receipts, loan proceeds, owner money paid in and cash from selling an asset. Outflows include wages, supplier payments, rent, tax and loan repayments when paid. A loan is an inflow but not sales revenue.
  • Net cash flow = total inflows − total outflows. Closing balance = opening balance + net cash flow. Next period’s opening balance is the previous closing balance in a continuous forecast. A negative flow may reduce a positive balance without producing a negative closing figure.

Record cash when money moves

Record cash when money movesEventCash forecast treatmentInvoice issued in JanuaryNot a receipt until paidCustomer pays in FebruaryFebruary inflowBank loan paid to thebusinessInflow, not sales revenueLoan principal repaidOutflow, not a sales costSupplier bill paidOutflow when paymentoccurs

Cash flow forecast

  • A cash flow forecast estimates the timing of receipts, payments and balances. It can identify likely gaps, support decisions and provide evidence for a funding application. Compare actuals with forecasts and update assumptions regularly.
  • The fictional three-month forecast begins with £2,000. January inflows £5,000 and outflows £4,000 close at £3,000; February inflows £3,000 and outflows £6,500 close at −£500 before extra finance; March inflows £6,000 and outflows £4,500 close at £1,000 on that unfinanced basis. A negative forecast signals a gap, not automatic failure. Month-end figures can hide a larger gap within a month.

Three-month cash forecast

Three-month cash forecastItem (£)JanuaryFebruaryMarchOpening balance2,0003,000−500Cash inflows5,0003,0006,000Cash outflows4,0006,5004,500Net cash flow1,000−3,5001,500Closing balance3,000−5001,000

Causes of cash flow problems

  • Cash problems can arise from late receipts, uncollectible customer debts, excessive inventory purchases, weak sales, unexpected payments or growth requiring working capital before customers pay. A late invoice is not automatically a bad debt; the customer may still pay.
  • Seasonal sales and credit terms can make cash timing uneven while some bills continue. In the fictional forecast, delaying £1,000 from January to February lowers January closing cash by £1,000, but February receives the delayed amount and still ends at −£500 before finance. Trace linked balances rather than subtracting the delay twice.

Move a receipt through both months

Move a receipt through both monthsForecast item (£)Base JanDelayed JanDelayed FebOpening balance2,0002,0002,000Cash inflows5,0004,0004,000Cash outflows4,0004,0006,500Net cash flow1,0000−2,500Closing balance3,0002,000−500

Improving cash flow

  • Collect overdue customer payments, negotiate longer supplier terms before the due date and reduce unnecessary future stock purchases. Existing inventory releases cash when sold and collected; simply reducing its recorded quantity does not create money. Avoid cuts that prevent sales.
  • An approved overdraft or loan can bridge a temporary gap but involves terms, costs and repayment. Asset sales give up the asset; sale and leaseback releases cash while retaining use but gives up ownership and creates lease commitments. Consider whether the problem is temporary timing or persistent losses.
  • An early-payment discount may accelerate collection but reduce receipts. On a fictional £1,000 invoice, 2% is £20 and payment would be £980 if accepted. Check the trade-off rather than assuming every cash remedy improves profit.

Evaluate a cash-flow response

Evaluate a cash-flow responsePossible responseImportant trade-offCollect overduereceiptsCustomer may still not payBuy less unneededstockAvoid shortages that lose salesAgree longer suppliercreditSupplier must agree; terms maycost moreUse an approvedoverdraftInterest, fees and limits applySell and lease back anassetLose ownership; future leasepayments

Effects

  • If payments cannot be met, suppliers may stop deliveries or staff and lenders may be affected, disrupting operations and potentially causing failure even if accounting profit is positive. The outcome depends on whether the gap can be covered or timing changed.
  • A projected negative balance before finance shows the amount needing attention under the stated assumptions. An agreed overdraft may cover it, but future interest and repayment need forecasting too. A positive month-end balance alone also does not prove all payments were affordable on their due dates.

An earlier receipt can cost money

An earlier receipt can cost moneyFictional itemAmountInvoice owed£1,000Early-payment discount2%Discount value£20Receipt if accepted£980

Slides

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Practice questions

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  1. 1.What is cash flow?

    Easy
    • Amovement of money into and out of a business
    • Bprofit
    • Crevenue
    • Dtax

  2. 2.What is liquidity?

    Easy
    • Atotal profit
    • Btotal revenue
    • Ctotal assets
    • Dability to pay short-term debts

  3. 3.What is a cash inflow?

    Easy
    • Aa cost
    • Ba loan repayment
    • Cmoney received by the business
    • Dmoney paid out

  4. 4.What is net cash flow?

    Easy
    • Aprofit plus tax
    • Binflows minus outflows
    • Coutflows minus inflows
    • Drevenue minus costs

  5. 5.What is a cash flow forecast?

    Easy
    • Aa prediction of cash in and out
    • Ba record of past sales
    • Ca tax return
    • Da price list

  6. 6.What is a bad debt?

    Easy
    • Amoney borrowed
    • Bmoney saved
    • Cprofit
    • Dcustomer money owed that is judged unlikely to be recovered

  7. 7.What is overtrading?

    Easy
    • Anot trading
    • Bsaving too much
    • Cexpanding too quickly without enough cash
    • Dselling too little

  8. 8.Which is a cash outflow?

    Easy
    • Aselling an asset
    • Bpaying wages
    • Creceiving a loan
    • Dreceiving sales

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