Key definitions
Cash — the money, physically and in the bank, that a business has.
Cash flow forecast — the money expected to flow in and out of a business.
Why is cash important to a business?
- To ensure that the business can survive and pay its expenses.
- If a business cannot pay its debts, it will have to sell its assets to make these payments.
Working capital
Why is working capital so important?
- To be able to pay for short-term expenses.
- To ensure that the business has enough finance to continue running so it won't have to sell assets.
Solving short-term cash-flow problems
How to overcome a problem in short-term cash-flow:
- Apply for an overdraft.
- Delay payment to suppliers (trade credit).
- Ask debtors to pay more quickly (collecting trade receivables).
- Sell business assets.
Worked example: cash flow forecast
Cash flow of a cookie business
Key formulas used in the forecast:
Total cash inflow = Payments from customers + Loans
Total cash outflow = Purchase of ingredients + Other expenses
Net flow = Total cash inflow − Total cash outflow
Closing balance = Opening balance + Net flow
Opening balance = last month's closing balance
| Item | January | February | March | April | May | June |
|---|---|---|---|---|---|---|
| Payments from customers | 3,000 | 4,000 | 1,000 | 2,000 | 2,000 | 3,000 |
| Loans | 0 | 0 | 10,000 | 0 | 0 | 0 |
| Total cash inflow | 3,000 | 4,000 | 11,000 | 2,000 | 2,000 | 3,000 |
| Purchase of ingredients | 1,000 | 2,000 | 1,000 | 1,000 | 1,000 | 1,000 |
| Other expenses | 500 | 800 | 200 | 400 | 500 | 500 |
| Total cash outflow | 1,500 | 2,800 | 1,200 | 1,400 | 1,500 | 1,500 |
| Net flow | 1,500 | 1,200 | 9,800 | 600 | 500 | 1,500 |
| Opening balance | 1,000 | 2,500 | 3,700 | 13,500 | 14,100 | 14,600 |
| Closing balance | 2,500 | 3,700 | 13,500 | 14,100 | 14,600 | 16,100 |