1

a Define the term cash flow.​[2]

Cash flow is the movement of cash into and out of a business over a period of
time.
b Explain one reason why a business might forecast its cash flow.​[3]
• To support applications for loans: almost all new enterprises require loans to
enable them to become established (and also during periods of expansion).
Banks and other financial institutions are far more likely to lend money to a
business that has evidence of financial planning.
• To help avoid unexpected cash-flow crises: 20 percent of newly established
businesses fail within two years of starting trading. A high proportion of such
businesses fail because of cash-flow difficulties. Similarly, many large and
established businesses encounter cash-flow problems which can result in the
closure of the business; planning helps to forecast and avoid such crises.

2 Distinguish between cash flow and profit.​[5]

Profit is the surplus of sales revenue over total costs, if any exists. Cash flow is
the movement of cash into and out of a business over a period of time. Just
because a business is profitable, it does not mean that it will hold large sums of
cash, or even have enough cash. A business may survive for some time without
making profits if its owners are prepared to be patient, but cash has to be
managed carefully in the short term to ensure that bills can be paid on time.

3 a State two reasons why a profitable business might become short of

cash.​[2]
It may have offered too much trade credit to its customers or be expanding too
quickly without planning for its needs for cash (overtrading).
b Explain why newly established businesses are vulnerable to cash-flow
problems.​[3]
Newly established businesses are unlikely to have large reserves of cash to draw
upon in times of difficulty and are therefore vulnerable to any delays of inflows of
cash. This can be worsened because they may not have sufficient financial
history to negotiate favourable trade credit terms with suppliers. They may be
expected to pay cash on delivery at the same time as having to offer customers
trade credit to win their orders.
4 Explain why some businesses need to hold larger reserves of cash than
others.​[5]
Some businesses need to hold larger cash reserves to trade safely and securely.
House builders and ship manufacturers may hold greater cash reserves because
they face a longer cash cycle. This means that there
is a longer time period between the cash outflow associated with producing a
product and the cash inflow from its sale.

5
a Explain the term overtrading.​[3]
Overtrading occurs when a business expands quickly without organising funds to
finance the expansion. Rapid growth normally involves paying for labour and raw
materials several months before receiving payment and this delay can result in
severe cash-flow problems.
b State two other possible causes of cash-flow
problems.​[3]
These include:
• allowing too much trade credit
• poor credit control
• external factors such as an unexpected fall in demand for the business’s
products.

6 a Define the term cash-flow forecast.​[2]

A cash-flow forecast is a document that records a business’s anticipated inflows
and outflows of cash over some future period, usually one year.

b Explain one reason why a business may prepare an inaccurate cash-flow

forecast.​[3}
There may be an unexpected rise in costs. Prices of raw materials such as oil
may increase without warning. Alternatively, the cost of labour may rise due, for
example, to a shortage of skilled workers.
Similarly, machinery breakdowns can impose unanticipated pressures on a
business’s cash flow. All of these factors could lead to higher than expected cash
outflows and smaller or negative cash balances as a consequence.

7 a Define the term trade payables.​[2]

Trade payables are short-term liabilities to suppliers for goods supplied or
services rendered.

b State three methods a business might employ to improve its cash-flow

position.​[3]
Relevant methods include:
• improved control of trade payables and trade receivables
• debt factoring
• arranging short-term borrowing
• sale and leaseback of assets
• reducing costs.

8 Explain the advantages and disadvantages of the use of debt factoring as

a method of improving a business’s cash-flow position.​[5] A major
advantage is that the immediate cash provided by the factoring means that the
firm is likely to have lower overdraft requirements and will pay less interest.
However, a disadvantage, especially for small or less profitable businesses, is
that to lose up to 5 percent of their earnings means that factoring is uneconomic
– it can eliminate much of their profit margin.

9 a State two assets a business might lease rather than buy.​[2]

Assets include:
• buildings
• machinery
• vehicles.
b Explain the disadvantages to a business of leasing assets.​[3]
The cost of leasing arrangements can be relatively high, which may have a
negative effect on the business’s cash position, causing continual outflows of
cash. It may also lead to lower profit margins, which could prove unpopular with
the owners of a business.

10 Explain why newly established businesses might face difficulties in

using some methods to improve their cash-flow position.​[5]
A newly established business may not be able to negotiate improved trade credit
terms with its suppliers as it does not have a sufficient trading history. A
bank may also be unwilling to grant an overdraft if it believes that the business is
too risky – and many new businesses are perceived to be high risk.