Professional Documents
Culture Documents
7 CASH FLOW
CASH VS PROFIT
Profit is the positive difference between a firm's total sales revenue and its total
costs of production
When a firm sells its product in credits, profit is made before the cash is received
Therefore, it is possible for a firm to be profitable but cash deficient. Conversely, it
is also possible to be cash rich but unprofitable.
THE WORKING CAPITAL CYCLE
Working capital refers to the cash or liquid assets available for the daily running of
a business.
A lack of working capital means that the firm has insufficient cash to fund its
routine operations.
The term liquidity refers o how easily an asset can be turned into cash
Highly liquid assets are those that can be converted into cash quickly and easily
without losing their monetary value, e.g. cash deposits at a bank.
CURRENT ASSETS
CURRENT LIABILITIES
THE CYCLE
For most businesses, there is a delay between paying for costs of production (such
as the purchase of stock and payment of wages) and receiving the cash from
selling their products.
CASH FLOW FORECASTS
A cash flow forecast is a financial document that shows the expected movement
of cash into and out of a business, per time period
Cash inflows usually come from sales revenue when customers pay for the
products that they have purchased.
Cash outflows refers to cash that leaves a business, e.g. when invoices or bills
have to be paid.
Net cash flow refers to the difference between cash inflows and cash outflows,
per time period.
REASONS FOR CASH FLOW FORECASTS
Banks need it to assess the financial health of the business seeking external
finance
Forecasts can be compared with actual cash flows to improve future predictions
and planning. Aid business planning
CONSTRUCTING CASH FLOW FORECAST
CAUSES OF CASH FLOW PROBLEM
Overtrading
This situation occurs when a business attempts to expand too quickly
Over borrowing
During times of rising interest rates, cash outflow on loan interest increases, putting further
pressure on a firm's working capital and liquidity position.
Overstocking
When a business holds too much stock as a result of an ineffective stock control system
Poor credit control
Problems arise when a firm offers customers an extended credit period, leading the business to
trade for long periods without cash inflows.
Unforeseen changes
Machinery breakdown, seasonal flunctuations, etc
INVESTMENT, PROFIT, CASHFLOW
Examples of how investment, profit and cash flow are interlinked include:
• When a firm obtains finance for investments, the cash inflow improves its liquidity
position.
STRATEGIES FOR CASH FLOW PROBLEMS
Overdrafts
Selling fixed assets
Debt factoring
Government assistance
LIMITATIONS