BUSINESS MANAGEMENT
3.7 Cash flow
Section 3 Finance and accounts
BUSINESS MANAGEMENT
Unit content
Content
Assessment
objective
The difference between profit and cash flow
AO2
The working capital cycle
AO2
Cash flow forecasts
AO2, AO4
The relationship between investment, profit and
cash flow
AO2
Strategies to deal with cash flow problems
AO3
Cash flow and the CUEGIS concepts
BUSINESS MANAGEMENT
The number one cause of business
failure
• What is the number one
cause of business failure?
• Discuss this question with
your partner.
• Write your answer on a
sticky note and place it on
the wall indicated by your
teacher.
BUSINESS MANAGEMENT
Cash flow
• Cash flow (or working capital)
refers to the cash or liquid
assets available for the daily
running of a business.
• Day-to-day expenditures
include items such as paying
for:
• Utilities
• Wages
• Raw materials.
• In order for firms to thrive, they
need to have more cash flowing
into the business than out of the
business.
BUSINESS MANAGEMENT
The difference between profit
and cash flow
BUSINESS MANAGEMENT
Profit vs.
cash flow
Read the information
in the table.
At the end of the
month which
company:
1. Earned the most
profit?
2. Has the most cash
available?
Firm X and Firm Y have raised
$10,000 capital to start up their new
businesses manufacturing windows.
Firm X
Firm Y
• Got $5000 worth of
raw materials, paid
upfront.
• Manufactured 500
windows in 29
days.
• On the 30th day,
they sold all 500
windows for $20
per piece.
• Got $5000 worth of
raw materials. They
got 30 days trade
credit from the raw
materials supplier.
• They manufactured
400 windows in 29
days.
• On the 30th day,
they sold all 400
windows for $16
per piece.
BUSINESS MANAGEMENT
Cash flow ≠ profit
Watch this video and answer the
following questions:
• For every financial
transaction, the activity is
recorded on the date the
transaction occurred.
1.
Can a firm be profitable yet
have insufficient cash?
2.
What will happen to the firm if
it is profitable but does not
have enough cash?
• This appears on the profit
and loss statement.
• However, the actual date
the cash payment is made
for the transaction can be a
different date.
• This appears on the cash
flow statement.
• This is due to trade credit
creating debtors and
creditors.
BUSINESS MANAGEMENT
The working capital cycle
BUSINESS MANAGEMENT
The working capital cycle
• The working capital cycle is the time difference between the
firm paying cash for its costs of production and receiving cash
from sales to customers.
Firm’s
cash
Goods are sold to customers for
cash. It takes 50 days to sell all
goods.
Sale of
goods
Total
time lag:
90 days
Firm pays cash for raw
materials. It takes 10 days for
the raw materials to arrive.
Production
costs
Firm produces goods. Production time takes 30 days.
BUSINESS MANAGEMENT
Liquidity
• Liquidity refers to how
easily an asset can be
turned into cash.
• Relatively liquid assets are
usually current assets
• i.e. they convert quickly
into cash.
• Relatively illiquid assets
are usually fixed assets,
but could include stocks of
raw materials that have yet
to be processed into
finished goods.
• i.e. they take a longer
time to turn into cash.
Relatively liquid
assets
• Cash
• Debtors
• Stock of
finished
goods
Relatively
illiquid assts
• Fixed assets
• Stock of raw
materials
BUSINESS MANAGEMENT
Liquidity crisis
• A liquidity crisis is when
there is insufficient cash
in the working capital
cycle.
• This is due to more cash
flowing out of the
business than flowing
into the business.
BUSINESS MANAGEMENT
Over to you
• In pairs, discuss the following:
“The idea of having too much cash
in a business is just as
unfavorable as having not enough
cash.”
• Feedback your discussion points
to the class.
BUSINESS MANAGEMENT
Cash flow and the working capital cycle
• When there is too little
cash, the working capital
cycle will be unable to
continue and the business
will become insolvent.
Insufficient
cash
• Liquidity
crisis
• Threat of
insolvency
• i.e. The business will fail
from being unable to pay
its debts.
• When there is too much
cash, there is more than
enough cash for the
working capital cycle to
continue.
• i.e. Cash sits idle instead
of being used to grow the
business
Excess cash
• Opportunity cost
of not using
cash to grow the
business
A firm must aim to have just the right
amount of cash to meet the needs of its
working capital cycle.
BUSINESS MANAGEMENT
Over to you
• Hoang textbook
• Question 3.7.1
McDonald’s
• Page 312
• Question 3.7.2
Le Royal Méridien Hotels
• Page 314
• Answer all parts
BUSINESS MANAGEMENT
Cash flow forecasts
BUSINESS MANAGEMENT
Anticipating cash flow movements
• A cash flow forecast is a
financial document that
shows the expected
movement of cash in and
out of a business over a
period of time.
• Cash flow forecasts
contain three key features:
• Cash inflows
• Cash outflows
• Net cash flow
Cash
inflow
Cash
Net cash flow outflow
BUSINESS MANAGEMENT
Classify the following items as cash inflow or
cash outflows
Item
1.
Sales revenue
2.
Rental income
3.
Dividends to shareholders
4.
Payment to creditors
5.
Wages
6.
Debtors
7.
Rent paid
8.
Purchase of stocks
9.
Interest received
10.
Bank loans
11.
Interest payments
12.
Sale of assets
Cash inflow or cash outflow?
BUSINESS MANAGEMENT
Classify the following items as cash inflow or
cash outflows - ANSWERS
Item
Cash inflow or cash outflow?
1.
Sales revenue
Cash inflow
2.
Rental income
Cash inflow
3.
Dividends to shareholders
Cash outflow
4.
Payment to creditors
Cash outflow
5.
Wages
Cash outflow
6.
Debtors
Cash inflow
7.
Rent paid
Cash outflow
8.
Purchase of stocks
Cash outflow
9.
Interest received
Cash inflow
10.
Bank loans
Cash inflow
11.
Interest payments
Cash outflow
12.
Sale of assets
Cash inflow
BUSINESS MANAGEMENT
Cash flow forecast features
Item
Definition
Opening balance
The amount of cash at the beginning of a
trading period (same as the previous
month’s closing balance).
Cash inflows
Any cash coming into the business.
Cash outflows
Any cash leaving the business.
Net cash flow
Cash inflows – cash outflows
Closing balance
Opening balance + net cash flow
BUSINESS MANAGEMENT
Worked example (page 316 Hoang textbook)
Sept ($)
Oct ($)
Nov ($)
Dec ($)
1,000
800
1,600
1,900
Cash sales
2,000
2,000
3,000
4,000
Total cash inflows
2,000
2,000
3,000
4,000
600
600
900
1,200
1,000
0
1,000
0
Other costs
600
600
800
1,000
Total cash outflows
2,200
1,200
2,700
2,200
Net cash flow
(200)
800
300
1,800
Closing balance
800
1,600
1,900
3,700
Opening balance
Inflows
Outflows
Stock purchases
Rent
BUSINESS MANAGEMENT
Complete this cash flow forecast
Sept ($)
Opening balance
Oct ($)
Nov ($)
Dec ($)
1,300
Inflows
Cash sales
700
650
500
900
Credit sales
450
800
200
450
Raw materials
400
200
375
600
Wages
500
500
500
500
Advertising
200
200
200
1100
Loan payment
300
300
300
300
Total cash inflows
Outflows
Total cash outflows
Net cash flow
Closing balance
BUSINESS MANAGEMENT
Cash flow forecast exercise - ANSWERS
Sept ($)
Opening balance
Oct ($)
Nov ($)
Dec ($)
1,300
1,050
1,300
625
Cash sales
700
650
500
900
Credit sales
450
800
200
450
Total cash inflows
1,150
1,450
700
1,350
Raw materials
400
200
375
600
Wages
500
500
500
500
Advertising
200
200
200
1100
Loan payment
300
300
300
300
Total cash outflows
1,400
1,200
1,375
2,500
Net cash flow
(250)
250
(675)
(1,150)
Closing balance
1,050
1,300
625
(525)
Inflows
Outflows
BUSINESS MANAGEMENT
Analysing a cash flow forecast
Look at the completed cash
flow forecast from the previous
slide.
1. Describe the total cash
inflow trend.
2. Describe the total cash
outflow trend.
3. Describe the net cash
flow trend.
4. Describe the closing
balance trend.
5. What conclusions can
you draw about the
liquidity position of this
company?
BUSINESS MANAGEMENT
Over to you
• Hoang textbook
• Question 3.7.3 Pranab & Co.
• Page 315
• Question 3.7.4 Wincent Wines
• Page 317
• Question 3.7.5 Menelao
Stationers
• Page 317
• Question 3.7.6 Bereti’s
Boutique
• Page 319
• Answer all questions
BUSINESS MANAGEMENT
The relationship between
investment, profit and cash flow
BUSINESS MANAGEMENT
Best and worst case financial outcomes
• The relationship between investment,
profit and cash flow must be managed
carefully.
• When managed well, a firm is likely to
meet its long-term objectives as its growth
strategies are underpinned by healthy
finances.
• When managed poorly, a firm will struggle
and eventually have to cease trading.
BUSINESS MANAGEMENT
Best case
financial
outcome
Consistent profits
eventually lead to
consistent positive
net cash flows
Consistent positive
net cash flows lead to
healthy liquidity
Healthy liquidity
allows for investment
into fixed assets to
maintain/increase
output
Consistent (or better)
levels of output
generate consistent
profits
BUSINESS MANAGEMENT
Worst case
financial
outcome
Consistent negative
net cash flows lead to
a poor cash balance
Reduced productivity
leads to reduced
profits or even losses,
which causes negative
net cash flows
Lack of ongoing
investment into fixed
assets results in
reduced productivity
A poor cash balance
prevents a firm from
making ongoing
investments into fixed
assets
BUSINESS MANAGEMENT
Strategies to deal with cash flow
problems
BUSINESS MANAGEMENT
Common causes of cash flow problems
Causes
Explanation
Overtrading
This is when businesses accept more orders than it has the capacity
to financially handle.
Overborrowing
High levels of debt mean a firm has to increasingly use more of its
cash inflows to repay loans and interest charges.
Over-stocking
Having more stock than the business is able to sell (i.e. convert into
cash) means that valuable cash is tied up as it is ‘stuck’ as inventory.
Poor credit
control
Liquidity problems occur when firms:
• Offer too many customers trade credit.
• Offer long trade credit terms.
• Chase debtors too slowly.
Unforeseen
changes
Liquidity problems occur when firms:
• Experience unexpected or erratic changes in demand (e.g. out-ofseason increases in demand).
• Experience unexpected expenditures (e.g. spoiled inventory due to
equipment failure).
BUSINESS MANAGEMENT
Liquidity crisis at Hong Kong Airlines
Hong Kong Airlines (HX) has
been struggling with cash
flow problems since 2018.
1. Watch this video and
identify the strategies
used by HX to improve
its liquidity position.
2. Explain whether HX can
continue using these
strategies indefinitely.
3. Other than the strategies
identified from the video,
what else can HX do to
improve its working
capital position?
BUSINESS MANAGEMENT
Reducing cash outflows
• Methods of reducing cash
outflows include:
• Seeking preferential
credit terms
• Seeking alternative
suppliers
• Better stock control
• Reduce expenses
• Leasing rather than
buying
BUSINESS MANAGEMENT
Increasing cash inflows
• Methods of increasing cash
inflows from revenues
include:
• Tighter credit control
• Accepting cash payments
only
• Changing pricing policy
• Improving the firm’s
product portfolio
BUSINESS MANAGEMENT
Seeking additional sources of finance
• Additional sources of
finance appropriate for a
liquidity crisis include:
• Overdrafts
• Selling fixed assets
• Debt factoring
• Government assistance
• Additional sources of
finance will increase cash
inflows into the business.
BUSINESS MANAGEMENT
Over to you
• Hoang textbook
• Question 3.7.7
Ducie’s Dance Studios Ltd.
• Page 322
• Answer all parts
BUSINESS MANAGEMENT
Theory of Knowledge
To what extent do cash flow statements reveal
the ‘truth’ about a business?
BUSINESS MANAGEMENT
Cashflow and the CUEGIS
concepts
BUSINESS MANAGEMENT
Cash flow and CUEGIS
• Cash is largely regarded as more important than profit
in the short run.
• Failure to use cash-boosting and cost-reduction
strategies will result in the insolvency of a business.
• A contingency fund is important to manage any
unexpected impacts on cash flow, particularly changes
from the external environment.
• Innovation in stock management software
allows firms to keep a close eye on
overstocking.
BUSINESS MANAGEMENT
Review tasks
• Hoang workbook
• Topic 3.7
• Pages 144 to 151
• Answer all questions