5.2.1 The importance of cash and cash flow forecasts (3)
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1.
Question 2
The following is an extract from a cash flow forecast for a new online business. (Figures in £)
| Month | Cash In | Cash Out | Net Cash Flow |
| Month 1 | 2000 | 2500 | -500 |
| Month 2 | 2500 | 2000 | 500 |
| Month 3 | 3000 | 2800 | 200 |
Identify any potential problems highlighted by this cash flow forecast. Suggest two actions the business owner could take to address these problems.
Potential Problems: The business experiences a negative net cash flow in Month 1, indicating a cash shortfall. This could lead to difficulties in paying bills and potentially hinder the business's growth.
Actions to Address Problems:
- Reduce Expenses: The business owner could review and reduce expenses, particularly in Month 1, to improve the cash flow. This could involve negotiating better deals with suppliers or reducing marketing spend.
- Increase Cash Inflows: The business owner could explore ways to increase cash inflows. This could involve offering discounts to encourage faster payments, improving marketing to attract more customers, or offering new products or services.
2.
Consider a small retail business. Create a simplified cash flow forecast table for the next three months. Include the following categories: Cash Inflows (Sales), Cash Outflows (Rent, Salaries, Stock Purchases). Assume the business starts with £5,000 in the bank. (You do not need to calculate specific amounts, just show the structure of the table).
Here's a simplified cash flow forecast table for a small retail business over three months:
| Month | Cash Inflows (Sales) | Cash Outflows (Rent) | Cash Outflows (Salaries) | Cash Outflows (Stock Purchases) | Net Cash Flow | Closing Cash Balance |
| Month 1 | £ | £ | £ | £ | £ | £ |
| Month 2 | £ | £ | £ | £ | £ | £ |
| Month 3 | £ | £ | £ | £ | £ | £ |
Note: The initial cash balance of £5,000 would be the starting point for the closing cash balance in Month 1.
3.
A small business is experiencing difficulty paying its immediate bills because it doesn't have enough cash on hand. Identify and explain three different methods the business owner could use to overcome this short-term cash flow problem. For each method, explain the advantages and disadvantages.
Here are three methods a business could use to overcome a short-term cash flow problem:
- Overdraft: An overdraft is a facility provided by a bank that allows the business to spend more money than it has in its account, up to a pre-agreed limit.
- Advantages: It provides immediate access to funds, is relatively easy to access, and can be a quick solution to a temporary cash flow shortage.
- Disadvantages: Overdrafts are expensive, with interest charges accruing daily. If the overdraft limit is exceeded, the bank may refuse to cover transactions, causing embarrassment and potentially damaging the business's reputation. It can also create a reliance on borrowing.
- Delaying Supplier Payments: The business can negotiate with its suppliers to extend the payment terms. This means paying the supplier later than the originally agreed-upon date.
- Advantages: It frees up cash in the short term, allowing the business to meet other obligations. It doesn't incur any direct cost.
- Disadvantages: Suppliers may be reluctant to grant extended credit, especially if the business has a history of late payments. It can damage the relationship with suppliers if not handled carefully. Late payment penalties may also apply.
- Asking Customers to Pay More Quickly: The business can implement strategies to encourage customers to pay their invoices faster. This could involve offering discounts for early payment, implementing stricter credit terms, or using more effective invoicing systems.
- Advantages: It improves cash flow directly and doesn't involve borrowing. It can also improve the efficiency of the business's credit control processes.
- Disadvantages: Customers may resist paying faster, leading to potential loss of sales. Stricter credit terms could deter some customers. Implementing new systems requires time and effort.
- Delay Purchase of Non-Current Assets: Postponing the purchase of new equipment or other long-term assets frees up cash that would otherwise be spent on the purchase.
- Advantages: Preserves cash for immediate needs. Allows the business to avoid incurring debt.
- Disadvantages: Can delay future growth and expansion. May reduce efficiency if essential equipment is delayed. Could lead to lost opportunities.