The Importance of Cash & Cash Flow Forecasts (Cambridge International IGCSE Business)

Why cash is important

Why is cash important?

• Cash is the 'blood' of a business, as without it, a business cannot survive

  • It is a liquid asset in the form of notes, coins and money in the bank

• A new business may have to pay cash on purchase for all of its supplies until its suppliers trust them enough to grant trade credit

  • A supplier may then give the business 30 or 60 days to pay for items they purchase
  • This means that the business can receive their stock now pay for it later, so the cash outflow is delayed
  • As the business sells its products, they receive money generated from the business revenue, which represents a cash inflow
  • At the end of the credit period, they pay the supplier (cash outflow), but the firm may still have half of its stock available for sale

• More established businesses need to ensure that they manage cash effectively to ensure that they do not run out of money

  • Cash-flow issues may put the business in a situation where it is :

    • Unable to pay key stakeholders, such as workers and suppliers

      • Production is likely to cease, as workers will not work without pay and suppliers will not supply goods if they are not paid

    • Unable to pay utility bills and rent

  • As a result, the business could be forced into liquidation and is, ultimately, likely to fail

Exam Hint Many students confuse cash, revenue and profit. Remember: cash is money available to pay bills, revenue is income from sales, and profit is what remains after costs. Keeping these distinct is essential in exams

Introduction to cash flow forecasts

• A cash-flow forecast is a prediction of the expected cash inflows and cash outflows, typically for the next three, six or twelve-month period

  • Typical outflows include payments for raw materials, paying staff wages and salaries, paying bills such as electricity and repaying loans
  • Typical inflows include receipts from sales, money received from a new bank loan, money from the sale of an asset and money from investors

The three month cash-flow forecast clearly shows how inflows and outflows of cash into a business are accounted for

Features of cash flow forecasts

Spec point — "main features of a cash flow forecast: cash inflow, cash outflow, net cash flow, opening balance, closing balance"

Features of cash flow forecasts

Cash inflows

• Cash inflows are sums of money coming into the business
• This includes items like sales revenue, loans received or money from investors

Cash outflows

• Cash outflows are sums of money leaving the business
• This includes payments for rent, wages, stock, bills or loan repayments

Net cash flow

• Net cash flow is the difference between cash inflows and cash outflows in a given period

  • If net cash flow is positive, the business has more cash coming in than going out
  • If it's negative, the business is spending more than it receives

• Net cash flow is calculated using the formula

$\mathrm{Net} \mathrm{cash} \mathrm{flow}=\mathrm{Cash} \mathrm{inflows}-\mathrm{Cash} \mathrm{outflows}$

Opening balance

• The opening balance is the amount of cash the business has at the start of a period, e.g., the beginning of the month
• It is usually the same as the closing balance from the previous period

Closing balance

• The closing balance is the amount of cash the business has at the end of the period

  • This figure shows whether the business will have enough money at the end of the month to cover its needs

• The closing balance is calculated using the formula

$\mathrm{Closing} \mathrm{balance}=\mathrm{Opening} \mathrm{balance}+\mathrm{Net} \mathrm{cash} \mathrm{flow}$