GCE PROFESSIONAL BUSINESS SERVICES

CASH FLOW

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Learning Outcomes
Students should be able to:
• define the term cash flow
• understand the distinction between cash flow and profit
• understand the importance of cash flow forecasting for financial decision
making
• construct and complete a cash flow forecast, including receipts (cash
inflows), payments (cash outflows) and opening and closing balances for a
business
• analyse a cash flow forecast
• analyse the benefits and limitations of cash flow forecasting for a business

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CASH FLOW - Definition

• Is the money coming into and going out of a

business over a period of time. Money comes
in through sales, capital, finance and money
goes through purchases, wages and overheads

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 CASH FLOW
Distinction between cash and profit
• Cash is all the money in the business, (eg coming in
through sales revenues or paid out through overheads)
• not all of this cash can be used in the calculation of profit,
for example purchasing a non current asset will cause a
reduction in cash, but will not impact on profit.
• The calculation of profit:
– also includes non-cash expenses (which are not therefore included in a
cash flow forecast) such as bad debts written off and/or depreciation.
– is subject to ‘accounting adjustments’ which mean that the profit/loss
for the financial period may not necessarily be the same amount as
the closing cash balance as at the end of the financial period.

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IMPORTANCE OF CASH FLOW

• Cash flow is important to a business in context

of decision making since a business:
– needs a supply of ready money
– needs to pay essential debts immediately
– Needs to maintain a good reputation with suppliers
– Needs to reduce finance costs by avoiding
overdrafts/loans
– Needs to plan ahead for the future

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IMPORTANCE OF CASH FLOW (Cont’d)

• Supports decisions taken in context of the

operational business plan
• Allows owner to plan business expenditure
• Facilitates spending decisions and reviews
• Highlights amount of debt finance that could
be repaid and prioritise related decisions
• Facilitates correct decision making in context of
resource allocation
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 CASH FLOW FORECAST

• CONSTRUCTION OF CASH FLOW FORECAST:

• Normally comprised of following key elements:
– Time period, amount, cash flow in/out, opening/clos. balances
Sample layout:
• Month Jan (£) Feb (£) Mar (£)

• Opening balance 10 (20) (20)

• Add cash flows in 20 50 100
• Less cash flows out (50) (50) (40)
• Closing balance (20) (20) 40
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CASH FLOW FORECAST
TYPICAL CASH FLOWS IN
• Cash receipts
• Cash payments from
customers
• Online payments from
customers
• Trade Receivable receipts
• Interest received
• Tax refunds
TYPICAL CASH FLOWS OUT
• Cash payments
• Non-current assets eg
vehicles
• Trade payables
• Purchases
• Expenses
• Tax payments
• Drawings (sole traders)
• Dividends (companies)
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PURPOSE OF A CASH FLOW FORECAST

• Enables business managers to make key decisions in

relation to setting business targets eg strategic
planning
• Shows management when the money is needed and
how much managers can make decisions to ensure
availability of funds
• Preparation of cash flow forecast should support
lending decisions when applying for a loan

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ANALYSIS OF A CASH FLOW FORECAST
• Cash flows change for the following reasons:
– Lease instead of outright purchase of non-current
assets eg buildings, equipment
– Delaying the purchase of non-current assets eg vehicles
– Shortening the average trade receivables collection
period
– Reduce Inventory Levels thus reduce cash tied up in
this type of asset
– Negotiation with suppliers to extend trade payables
– Sale of assets, other sources of income stated

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 CASH FLOW FORECAST - BENEFITS
• Facilitates improved planning and control of business
activities – eg payment dates for expenses are known
• Enables managers to forecast future cash flows more
accurately – eg deficits can be avoided by postponing
certain payments
• Allows managers to anticipate ‘peaks’ and ‘troughs’ in the
cash cycle and take corrective action – surpluses can be
re-invested to generate additional income
• Assists co-ordination between managers – eg agreement
of an investment/project start date

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 CASH FLOW FORECAST - LIMITATIONS
• Cash flow estimates and may not be entirely accurate – a
cash deficit may occur if costs are underestimated
• Cash Flow Forecasts are subject to inaccuracies as the
data may change due to a number of external factors
which are beyond the control of business managers,
including: changes in economic conditions, changes in
interest rates, seasonal fluctuations and global events –
eg interest costs may increase by £10,000 causing a cash
deficit
• Forecasts only consider cash payments and receipts only –
ignores non-cash expenses which reduces profits
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Learning Check
Can you:
• define the term cash flow
• understand the distinction between cash flow and profit
• understand the importance of cash flow forecasting for financial decision
making
• construct and complete a cash flow forecast, including receipts (cash
inflows), payments (cash outflows) and opening and closing balances for a
business
• analyse a cash flow forecast
• analyse the benefits and limitations of cash flow forecasting for a business

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