C1 Cash Flow Forecasts
Cash flow is the money entering and leaving the business over a period of time. A cash flow forecast is a prediction of future inflows and outflows over a period of time whereas a cash flow statement is a record of inflows and outflows that have already occurred.
A cash flow forecast is a prediction of the inflows and outflows of a business across a period of time in the future. A 12 month cash flow forecast will usually itemise the predicted inflows and outflow each month. This allows a business to anticipate periods of negative cash flow and take preventative action.
Cash inflows may include money received from cash sales and credit sales, loans, money invested by owners, grants and sale of fixed assets.
Cash outflows are the amounts of money leaving the business in different time periods. They may include premises costs, staff costs, costs of equipment and raw materials, loan and interest payments and vehicle costs.
Net cash flow is the inflow per time period minus the outflow for the same time period.
The closing balance is the net cash flow plus the opening balance. The opening balance for one time period is the same as the closing balance for the previous time period.
Constructing a Cash Flow Forecast
Opening balance = closing balance of previous month. For a new business, opening balance may be zero unless otherwise stated.
Net cash flow = opening balance + closing balance
Closing balance = net cash flow + opening balance
Analysing Cash Flow Forecasts
Cash flow problems arise when a business has more outflows than inflows. Without another source of finance, a business may not be able to pay its debts and become insolvent.
Reasons for negative cash flow include low sales through poor marketing or unexpected changes in the market, late payments from customers or offering long credit terms, holding too much stock, high spending on assets, high costs of raw materials and over staffing.
Actions that can be taken by a business to address cash flow difficulties. Cash flow can be improved by increasing sales through promotion or changes to prices or decreasing costs through making deals with suppliers and improving efficiency. The timings of inflows and outflows can be adapted to improve cash flow, for example giving incentives to customers to pay sooner or negotiating longer credit terms with suppliers will improve cash flow. For short periods of negative cash flow a business may decide to arrange an overdraft or business loan. Where large expenditure on capital items such as vehicles and equipment cause negative cash flow, a firm may decide to rent the item or use hire purchase to spread out the payments.
Benefits and Limitations of Cash Flow Forecasts
Benefits of cash flow forecasts include anticipating problems early so solutions can be found, being able to use as evidence when applying for funding, highlighting periods in advance where an overdraft might be needed to cover expenses and avoiding business ventures which are likely to fail due to poor cash flow
Limitations of cash flow forecasts include the time it takes to construct them, the reliability of the data used and the uncertainty of what will happen in the future making them potentially unreliable.
