3.7 CashFlow

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Difference between Profit and Cash flow

Ice cream manufacturer

BUSINESS BUYS EGGS, DAIRY AND FRUIT SALES OF ICE CREAM TO RETAILERS
FROM SUPPLIERS
Total costs = $6 000 PRODUCTION OF ICE CREAM TUBS Sales revenue = $10 000

AGREES PAYMENT TO SUPPLIERS IN 30 DAYS AGREES TO GET PAID IN 60 DAYS

What sort of problem?


Ice cream manufacturer

BUSINESS BUYS EGGS, DAIRY AND FRUIT SALES OF ICE CREAM TO RETAILERS
FROM SUPPLIERS
PRODUCTION OF ICE CREAM TUBS
Total costs = $6 000 Sales revenue = $10 000

AGREES PAYMENT TO SUPPLIERS IN 30 DAYS AGREES TO GET PAID IN 60 DAYS

What sort of problem?

PROFIT = TR – TC = 10 000 – 6 000 = $ 4000 NO PROBLEM REGARDING PROFITABILITY

HOWEVER, BUSINESS NEEDS TO PAY SUPPLIERS BEFORE IT RECEIVES FROM CUSTOMERS


LIQUIDITY PROBLEM
WORKING CAPITAL CYCLE
WORKING CAPITAL CYCLE

SHORT WORKING CAPITAL CYCLES LONG WORKING CAPITAL CYCLES


(receive cash for their sales almost immediately) (long production and/or high price)

Hair salons Diamond rings (price – installments?)


Taxis Cars (long production)
Fishing Agriculture
THE LONGER THE WORKING CAPITAL CYCLE

THE HIGHER THE CHANCE THE BUSINESS WILL NEED CASH AT SOME POINT

PLAN FOR short term LOANS, OVERDRAFT, ETC

CASH FLOW FORECAST


LET’S THINK FROM A CASH PERPSECTIVE

ACTUAL CASH IN THE BUSINESS

CASH IN THE BANK ACCOUNT

CASH INFLOW CASH OUTFLOW


BUSINESS

Payments in cash received Payments in cash made


by a Business by a Business

What examples can you think of ?


CASH INFLOW CASH OUTFLOW
BUSINESS

• SALES REVENUE IN CASH • CASH PAYMENTS TO SUPPLIERS (buying stocks)


• CREDITORS CASH PAYMENTS (when it is due)
• PAYMENTS IN CASH MADE BY • CASH PAYMENT TO UTILITY PROVIDERS
DEBTORS (when its due) • WAGES
• RENT
• LOANS FROM A BANK • ADVERTISING
• LOAN REPAYMENT (inc interest)
OTHERS: • DIVIDENDS
RENTAL INCOME FROM PROPERTY THE BUSINESS OWNS
INTEREST FROM SAVINGS ACCOUNTS

IT IS THE FIRST TIME THAT WE CONSIDER LOANS AS an INFLOW OF CASH


THE SIZE OF THE LIST ILLUSTRATES THE IMPORTANCE OF A BUSINESS HAVING ENOUGH CASH AVAILABLE
TO KEEP FUNCTIONING

NET CASH FLOW = CASH INFLOW - CASH OUTFLOW


PER TIME PERIOD
AIMING AT A POSITIVE NET CASH FLOW FOR EACH PERIOD

PLANNING TOOL = CASH FLOW FORECAST


CASH FLOW FORECAST

IS A FINANCIAL DOCUMENT THAT SHOWS THE EXPECTED MOVEMENT OF CASH

INTO AND OUT OF THE BUSINESS PER TIME PERIOD

KNOWING IN ADVANCE WHEN THE BUSINESS IS LIKELY TO FACE A PERIOD OF CASH SHORTAGE

PLAN AHEAD

AVOID LIQUIDITY PROBLEMS


This is what FORECAST it looks like
6 month Forecast
Looking at features and numbers

Note: You will find examples where Opening Balance is


before Closing balance

-
Percentages

Sales revenue January = $ 1 000 Sales revenue January = $ 1 000

Costs of sales = 20% of sales Sales in February increased by 20% = ?

Cost of sales = ?

Sales revenue January = $ 1 000

Costs are 75% of sales =

Sales in February increased by 11% =


Note: Opening balance should be on top
What if Sales are not 100% prompt payment ?
$

50% credit

Costs are 20% of sales ?


What if Sales are not 100% prompt payment ?

Costs 400 400 200 200 200 200


Important elements to remember:

1) Check if sales are always prompt payment or if the business gives credit to customers

2) Cost of sales, when given as a % of sales, are always calculated using Total sales (even if part of sales were on credit)

3) Salary is always an outflow (even if it is the owner’s salary)

4) Loan is an inflow when the Business receives it (usually this is the case in questions)

5) Interest is an outflow (unless it says specifically that the business receives interest)

6) All flows need to be registered


NET CASH FLOW = CASH INFLOW - CASH OUTFLOW
ANOTHER OPTION IS :
INVESTMENT – CASH FLOW – PROFIT

In Business Management, the term investment refers to the purchase of fixed assets (such as
equipment and machinery), with the intention of creating a financial return (profit) in the future. It is
therefore also known as capital expenditure.

Investment often requires a large initial amount of cash (for purchasing the fixed assets), so this can have
a negative impact on the organization’s net cash flow.

However, in the long run, the business intends for the investment expenditure to generate a profit for the
organization and improve its net cash flow.

Despite the risks, investment expenditure is important for an organization’s survival and sustainability. By
contrast, the lack of investment can negatively affect businesses as they fail to adapt to changing needs
and wants in the marketplace.
IF AT THE END OF THE PERIOD, THE SALES REVENUE IS HIGHER THAN THE COSTS = PROFIT

HOWEVER

INFLOW

Connected to the Working Capital Cycle


INVESTMENT – CASH FLOW – PROFIT

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