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Accounting & Finance

Topic 4: Forecasting and managing Cash flows

Forecasting cash flows:

Cash flow Forecast:
It is the estimate of a firm’s future cash inflows and outflows. The aim is to improve financial
planning. A cash flow forecast has four elements:
1. Cash Inflows
2. Cash Outflows
3. Opening Balance
4. Closing Balance
Cash flow statement:
• This statement is prepared by the financial accountants of the co. and it will record all
transactions which took place during the year. E.g. Co. will prepare cash flow statement
for year 2012 and in this it will record all cash transaction for that time period.
• A cash flow statement is a financial accounting document, which shows the cash inflows
and the cash outflows for a business over the past 12 months. It indicates those months in
which the business suffered a cash flow crisis (where cash out flows were greater than cash
inflows) and it will also highlight those months in which the business was cash rich (i.e.
more cash inflows than cash outflows). It allows a business to prepare a cash flow forecast
for the forthcoming year, by basing the estimated cash inflows and outflows on the results
from the previous year.
What additional information does the Cash Flow Statement give about the financial position
of a business?
• It Discloses information related to any change in long term loans.
• Provides information regarding new share issue.
• Provides information regarding new fixed assets investment.
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• Provides information regarding disposal of fixed assets.
• Provides information regarding dividend payment to shareholders.
Cash flow forecast statement
A statement prepared to predict future inflows and outflows of cash. It is prepared by the
management accountants of the company.
Importance/reasons/benefits of cash flow forecast statement
• It helps to forecast cash flows for a coming time period.
• It helps to identify that time period in which cash flow crisis might be expected.
• It might also help to select a suitable source of finance.
• It will help to determine whether co. will be able to start a new investment projects or not.
• It helps to determine credit time to be allowed to credit customer’s/accounts receivables. E.g.
if cash position is expected to be strong then more credit time might be allowed or vice versa.
• Might be demanded by bank while getting loans as it will help bank to determine whether
business will be able to repay loan installments or not. It might help prevent business going
into a project that will not be successful.
• It will help business to spot problems early so it can make plans for the necessary solution.
(E.g. it will highlight whether business is holding too much stock or whether its collection is
less than it should be or that it will be short of cash at a particular time).
• It will inspire confidence in lenders and banks that business may have to approach for finance.

Sources of cash inflows and outflows:

Inflows Outflows
Owner's/shareholder's investment. Purchase of fixed assets.
Receipts of bank loan. Cash purchases.
Interest on savings and investment. Payments to supplier’s/accounts payables.
Increase in bank overdraft. Expenses payment. E.g. salaries etc.
Cash sales. Loan repayments.
Receipts from credit customer’s/accounts Dividend payment.
receivables. Tax payment.
Government grants. Advertising.
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Donations
Sale of fixed assets.

Format of cash flow forecast statement:

January February March

Cash Inflows
Trade Receivables 10,000 15,000 5,000
cash sales 20,000 50,000 2,000
Total Cash in 30,000 65,000 7,000
Cash outflows
Materials 10,000 3,000 4,000
Wages 2,000 5,000 6,000
Rent 4,000 6,000 7,000
Total Cash out 16,000 14,000 17,000
Net Cash flow 14,000 51,000 (10,000)
Opening balance 5000 19,000 70,000
Closing balance 19,000 70,000 60,000

Limitations of cash flow forecast statement/budget:

• Its preparation will consume a lot of time.
• It can be a costly process because business will need the assistance of accountant or financial
adviser.
• It is just a forecast and does not guarantee actual results.
• It only considers financial/quantitative factors and ignores non-financial/qualitative factors.
• It uses historical data and thus is not a current or totally accurate.
• It is not a proper "financial statement" of where the business is as it does not include company's
assets, shares, debts, savings or future investment.
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• It is produced by the staff of the company who may be over confident and hence it is biased
and not fully accurate.
How to improve cash flow position:
• A business can take following steps to improve its cash flow position.
• It can convince its bank to provide overdraft facility, this will provide instant cash however,
interest payment might increase.
• It can demand more time from its supplier for payment, however they may demand interest on
the overdue amount.
• It can reduce price of its products with a view to increase sales/cash inflows, however it might
reduce profit margin and affect brand image.
• It can sell goods to its customers on cash rather than on credit. This will increase amount of
cash inflows. However, some customers might get alienated resulting in loss of market share.
• It can sell off some fixed assets. Instant inflows will take place however; business might face
shortage of fixed assets.
• Business can reduce its stock level. To get rid of the piled up stock it can announce discount
or sales. However, this could result in loss.
• It can convince its credit customers to make early payments by offering them cash discount.
However, it might result in decline in profit margin.

Difference between cash and profit:

Cash Profit
It is defined as the amount of cash which is It is defined as the excess of total revenue over
available with the Co. to meet its cash total cost.
requirements. Profit = TR-TC
The amount of cash will only increase/decrease In profit calculation we include both cash and
with the amount of cash sales/expenses. credit revenues and expenses.
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Reasons why the amount of cash and profit cannot be equal/ how highly profitable firm can
still face cash flow problems?
Cash Profit
Only increases with the amount of cash sales Depreciations recorded as an expense
but Will increase with the amount of total therefore Depreciation will not affect cash
revenue i.e. cash and credit sales so the but profit will it will decrease the amount of
amount of total cash and credit sales so the profit. So company decrease. so business will
amount of profit will revenue so business have more cash but will be low profitable but
will have less cash but high profit be high but still it would be having low profit more cash.
co will be having lesser amount of cash. Cash will decrease due to payment of
Will decrease due to purchase of fixed assets dividend Payment of dividend does not affect
but Purchase & of fixed assets will not affect income.
profit as it profit will not be affected, so statement as • it is recorded in appropriation
business will less be not included in income account, but it will result in cash outflow so
statement. As a result of cash but high profit profit will be high but low cash.
and it might end up with cash this business
will have high profit but low cash flow crisis.
but it will not affect profit, so business will
be having low cash but high profit.