Understanding Cash Flow: Inflows, Outflows & Cycle

• Cash is vital for a firm to pay its workers, suppliers, landlord, and government; without it, the business risks liquidation.
• Adequate cash is essential to cover short-term payments.

Cash Flow

• Cash flow consists of cash inflows and outflows over a specific period.

Cash Inflows

• Cash inflows represent money received by the business:
  • Sales revenue from product sales
  • Payments from debtors (customers who bought goods on credit)
  • Loans from external sources
  • Proceeds from selling business assets
  • Investments from investors

Cash Outflows

• Cash outflows are money paid out by the business:
  • Purchasing goods and materials
  • Paying wages, salaries, and other expenses
  • Purchasing fixed assets
  • Repaying loans
  • Payments to creditors (suppliers who provided items on credit)

Cash Flow Cycle

• Illustrates the movement of cash within a business.
• Cash flow differs from profit; profit is the surplus after deducting total costs from sales.
• Profit includes all income and payments, whether received/paid or not, while cash flow only considers actual cash transactions.

Cash Flow Forecasts

• A cash flow forecast estimates future cash inflows and outflows, typically monthly.
• It helps managers determine:
  • Cash availability for paying bills, buying assets, or repaying loans
  • How much bank lending is needed to avoid insolvency
  • Whether excess cash can be used profitably

Cash Flow Components

• Cash inflows are listed first, followed by cash outflows.
• Total inflows and outflows are calculated for each period.
• Opening cash/bank balance: cash held at the start of the month.
• Net Cash Flow = Total Cash Inflow – Total Cash Outflow
• Closing cash/bank balance: cash held at the end of the month, calculated by adding net cash flow to the opening balance.
• The closing balance of one month becomes the opening balance for the next.
• Figures in brackets indicate a negative balance (net cash outflow).

Uses of Cash Flow Forecasts

• Essential during business setup to estimate cash needs for rent, assets, advertising, etc.
• Banks require a cash flow forecast when a business applies for a loan to assess lending needs, duration, and repayment ability.
• Helps manage cash flow, plan for overdrafts to avoid negative balances, and decide on repaying loans or creditors if there's excess cash.

Overcoming Cash Flow Issues

• To address a negative cash flow forecast:
  • Increase bank loans to inject cash, but consider interest payments and eventual repayment.
  • Delay payments to suppliers for short-term relief, but be aware of potential supply and discount issues.
  • Request quicker payments from debtors, potentially shifting credit customers to cash sales.
  • Delay or cancel capital equipment purchases to reduce outflows, but be aware of potential efficiency losses.
• Long-term solutions include attracting investors, cutting costs, developing new products, and increasing efficiency to boost inflows.

Working Capital

• Working capital is the capital needed for short-term, day-to-day expenses.
• Represents liquid assets that can be quickly converted to cash to cover debts.
• Working capital includes:
  • Cash for expenses
  • Cash due from debtors, who can be asked to expedite payments
  • Cash in the form of inventory, which can be sold to generate inflows
• Too much inventory leads to high costs, while too little can halt production.

Explore cash flow dynamics: inflows (sales, loans, investments) and outflows (purchases, wages, loan repayments). Grasp the cash flow cycle and its distinction from profit. Learn about the crucial role of liquidity for business survival.