Cashflow – DH Jan 11

Cashflow

Higher Business Management

Cashflow – DH Jan 11

Cashflow Management

• Cashflow management is all about the movement of money (cash) in and out of a business

• Cash and cash management are the most important aspects of business

• Without cash the business will fail• A lack of cash is one of the most

common reasons for business failure (especially new businesses)

Cashflow – DH Jan 11

Cash MovementCASH IN• Profits• Sale of fixed assets• Sale of stock• Decreases in debtors• Capital introduced• Loans received• Increases in

creditors

CASH OUT• Losses• Purchase of fixed

assets• Purchase of stock• Increases in debtors• Drawings or

dividends paid• Loans repaid• Decreases in

creditors

Cashflow – DH Jan 11

Positive and Negative Cashflow

Cashflow – DH Jan 11

Liquidity

• The ability to have access to cash or near cash assets

• This allows the organisation to meet their everyday commitments

• The more liquid an organisation the better able it is to pay off short-term debts

Cashflow – DH Jan 11

Cashflow Statement• The Cashflow Statement is NOT the same as a

Cashflow Forecast• It is historic, whereas a forecast/budget is based

on future cashflow• PLCs must provide a Cashflow Statement by law• Small organisations are NOT required to publish

cashflow statements, but are encouraged to do so• Cashflow Statements show the sources and uses

of cash during a financial period• The purpose is to reconcile the increase/decrease

in cash with the profit/loss for that year

Cashflow – DH Jan 11

Sources of Cash Flow Problems• Tying up too much cash in stock• Allowing customers too much credit• Customers not paying within agreed

credit terms• Borrowing too much finance at high

interest repayments• Owners taking too many drawings• Purchase of capital items (e.g.

equipment)• Low sales

Cashflow – DH Jan 11

How to Improve Cash Flow• Offer discounts and promotions to encourage

cash sales and reduce stock levels• Sell any unnecessary fixed assets• Encourage overdue customers to pay their

bills• Arrange credit with suppliers• Seek another source of finance• Owners draw less• Purchase cheaper raw materials• Purchase items on hire purchase

Cashflow – DH Jan 11

Questions

1. Identify 4 sources of cash flow problems and justify one solution for each source you have identified. (2005, Section 2, Q5d)

(8 marks) 2. Distinguish between a Cash Budget

and a Cashflow Statement.(2 marks)

Cashflow – DH Jan 11

Solutions1. Identify 4 sources of cash flow problems and suggest one solution for each

source you have identified. (2005, Section 2, Q5d)(8 marks)

Sources of Cash Flow Problems Solutions

Too much money tied up in stock Introduce JIT

Allowing customers too long to pay Offer discounts to encourage prompt payment

High levels of borrowing along with high interest rates

• Sell any unused assets• Reduce loans by e.g. increasing number of

investors

Debtors not paying on time Debt factoring

High drawings Arrange overdraft/loan

Low sales • Offer discounts/promote cash sales• Promote product or service

Purchasing capital equipment • Sale and leaseback• Extended credit

High expenses • Cut costs• Reduce waste/economise• Deferred payment (HP, leasing)

Cashflow – DH Jan 11

Solutions2. Distinguish between a Cash Budget and a Cashflow Statement.

(2 marks)• A Cashflow Statement is a historical document, whereas a Cash

Budget looks at future income and expenditure.

• A Cashflow Statement must be produced by PLCs by law, conversely a Cash Budget is not a legal requirement.

• A Cashflow Statement is for external purposes, however a Cash Budget is for internal use.

Cashflow – DH Jan 11

Questions

3. Explain why firms can have a healthy profit but experience cash flow problems.(2007, Case Study, Q5a)

(4 marks) 4. Describe the term liquidity.

(2 marks)

Cashflow – DH Jan 11

Solutions3. Explain why firms can have a healthy profit but experience cash flow

problems. (2007, Case Study, Q5a)(4 marks)

• Too much money tied up in stock• Unwillingness to borrow due to high interest rates• Owners take large drawings from profits• Customers taking too much time to pay• Customers allowed too much time to pay• Allowing customers to have a high credit limit• Difficulty in raising finance• Purchasing large amounts of Fixed Assets (high capital expenditure)

Cashflow – DH Jan 11

Solutions4. Describe the term liquidity.

(2 marks)

• The ability to have, or have access to, sufficient cash, or near cash assets

• Purpose is to meet the everyday commitments of running an organisation

• It is vital for the short-term survival of the organisation• Ability of current assets to meet current liabilities• A "liquid" stock is a stock with a lot of volume that is easy to

buy and sell