Cash flow forecasting and

working capital
Chapter 23
 Lesson Objectives
● the importance of cash flow to business
operations
● how a cash flow forecast is constructed and
how it can be amended
● how firms can run short of cash and the likely
consequences of this
● how a short-term cash flow problem can be
overcome
● the importance of working capital.
What is cash in business terms?
• Cash is a liquid asset. This means that it is
immediately available for spending on goods
and services.
 What is cash flow?
• CASH FLOW – the movement of money
into and out of a business bank account

INFLOWS refers to OUTFLOWS refers

money received by the to money paid out by
business during a period the business during
a period of time
of time

EXAMPLES: EXAMPLES:
•Sales revenue •Purchases
•Capital •Rent
BUSINESS
•Loans •Wages & Salaries
•Grants
Cash inflow and cash outflow
 Cash inflow
• Five of the most common ways:
– By the sale of goods for cash
– Through payments made by debtors
– By borrowing money from an external source
– Through the sale of assets of the business
– From investors
 Cash outflow
• Five of the most common ways:
– By purchasing goods or materials for cash
– By the payment of wages, salaries and other
expenses in cash
– By purchasing fixed assets
– By repaying loans
– By paying creditors of the business – other firms who
supplied items to the business but who were not paid
immediately
For each of the transactions, tick the correct
column to indicate whether it represents a cash
inflow or a cash outflow for Good Hope Enterprises
Ltd.
 Task – Business
Using any business of you choice

•Make a list of all of the money that would come

into the business of in the first 6 months of trading
of a year. This money is known as inflow
•Make a list of all of the money that would go out of
the business of in the first 6 months of trading of a
year. This money is known as outflow
 You should have included the
following - inflow
• From Sales
– Cash from sales
– Cash from credit sales (comes in after a time lag)
• From investors
– Cash from investors putting capital into the business
to buy a share in the business.
• From lenders
– Cash from a bank loan
• From disposal of assets
– E.g cash from disposal of assets e.g. selling cars.
 You should have included the
following - outflow
• Purchasing stock
• Paying creditors – these are people you owe money to
e.g. banks or other businesses
• Paying wages
• Paying rent
• Paying insurance
• Paying for advertising
• Paying tax
• Paying interest on debts
• Purchasing items on credit (when you pay for them at a
later date)
 Definition to learn:
• A CASH FLOW • Working capital cycle –
CYCLE shows the the longer this cycle
stages between takes to complete, the
paying out cash for more working capital
labour, materials, etc. will be needed
and receiving cash
from the sale of
goods.
 Working capital

•Working capital – captial (money) needed to pay for raw

materials , day-to-day running costs (e.g. bills, expenses,
build up stocks) and credit offered to customers

•Working capital is very important to any business

•Without enough working capital a business could be

forced to stop trading
 Watch this short video to review
working capital and the importance
of the working capital cycle:

https://youtu.be/2yrI2sM8LhI
 Example
• Good Hope Enterprises Ltd records the following
transactions over the month of June:

Goods sold to $40,000 (50% cash; 50% on one

customers month’s credit)
Costs of goods sold $15,000 (paid for in cash)

What was the gross profit in June?

Assuming the business started the month with no cash, how

much cash did it have at the end of June? (Ignore any other
transactions.)

Why is the cash lower than the profit for June?

 Insolvency
• Can profitable businesses run out of
cash? Yes – and this is a major
reason for businesses failing. It is
called insolvency.
 The importance of cash
• If a business does not have cash then the following
problems could occur. Copy this into your books
Business has a lack of cash

Business is unable to pay bills/staff

Suppliers stop delivering as

they have not been paid.

Business may be taken to court

because they can’t pay creditors
(people they owe money to)

Business becomes insolvent

(can no longer pay its debts)
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 What is a cash flow forecast?
• A business needs to plan to ensure it has
enough cash to survive. To plan for this a
business will create a cash flow forecast.
• A CASH FLOW FORECAST is an estimate of
future cash inflows and outflows of a business,
usually on a month by month basis. This will
then show the expected cash balance at the end
of each month.
 What is Net cash flow
• Key Term: Net cash flow is the difference,
each month, between inflows and outflows

• Net cash flow = Inflow – Outflow

• Or

• Net cash flow = Receipts - Payments

 Why would a business use a cash
flow forecast
• A business will use a cash flow forecast to
– See if the business expects to have a suitable
amount of cash to survive
– See if the business needs to take any actions
to avoid a shortage of cash in the business
– See how well the business should be
performing after a period of time.
– Show to the bank to discuss if a loan is
needed and how a loan would be repaid.
 How to solve cash flow
problem?
• Cut costs 
• Cut stocks
• Delay payments to suppliers 
• Reduce the credit period offered to
customers 
• Cut back or delay expansion plans 
Long term measures to solve cash
flow problem
• Attracting new investors – sell more
shares but will affect ownership of the
business
• Increasing efficiency –But will be
unpopular with employees
• Developing new products that will attract
new customers – but takes long time and
needs cash in the short run
• Delay payments to suppliers – a dangerous game,
but widely used in business.  By taking longer to pay
bills owed, a business can reduce cash outflows (at
the risk of damaging relationships with suppliers
though).
• Reduce the credit period offered to customers –
this is easier said than done.  By asking customers to
pay for their purchases quicker, a business can
accelerate cash inflows. However, there is no
guarantee that customers will agree. They may need
to be given a financial incentive, such as a prompt-
payment discount.
• Cut back or delay expansion plans – many of the
biggest cash outflows occur when a business is
expanding (e.g. opening new offices or shops, adding
a production line or factory).  By delaying this
expansion, cash can be conserved in the short-term.
Building a cash-flow forecast
To build a cash-flow forecast you need to have the
following information

Opening Balance - the amount of money held by the

business’ bank account at the start of the period/month
Cash inflows – the amount of money expected to go into
the bank account in that month
Cash outflows – the amount of money expected to leave
the bank account in that month
Closing Balance – the amount of cash expected to be in
the bank account at the end of the period/each month
 What is the net cash flow if the
cash inflows for the month are
£620 and the cash outflows are
£1150?

a) -£1770
b) -£530
c) £530
d) £1770
 Building a cash-flow forecast

  January February March April

(£) (£) (£) (£)

Opening Balance 10,000 15,000 (5,000)   

Cash in-flows 35,000 45,000 50,000 

Cash outflows 30,000 65,000  40,000

Net cash flow (inflows- 5,000 (20,000) 10,000  

outflows)

Closing Balance 15,000 (5000)  5,000