Cash flow forecast
Contents: 9 sections
Why cash is what closes a business
Cash is the money a business can spend today. Wages, rent, tax bills and supplier invoices all fall due on a date somebody else chose, and none can be settled with an unpaid invoice or a warehouse full of stock.
This is why a business can be profitable and still fail. Profit counts a sale on the day it is made, whether or not the customer has paid, while cash is counted on the day the money moves. A builder who finishes a $90,000 job in March and is paid in July has a profit in March and no money in April, and the wages still go out every Friday. When a question asks why a growing, profitable business ran out of money, that gap is the answer.
What a cash flow forecast is
A cash flow forecast estimates the money a business expects to flow in and out over each of the coming months, and the bank balance left at the end of each one.
It is used in four ways:
- To spot a shortage before it happens, while there is still time to arrange an overdraft rather than beg for one.
- To show a bank when the money will be needed and when it comes back, which any loan application requires.
- To time large purchases so they fall in a month that can absorb them.
- To check afterwards whether the business is running to plan.
The 0264 syllabus states that candidates will not be assessed on constructing a cash flow forecast. You will be asked to complete missing figures in a printed one, amend it when a figure changes, and say what it shows. So practise reading forecasts, not drawing them.
The five parts, and the two rules that link them
| Part | What it is |
|---|---|
| Cash inflow | Money coming into the business in the month: cash sales, payments from credit customers, a loan received, money from selling an asset |
| Cash outflow | Money going out in the month: materials, wages, rent, insurance, loan repayments, buying equipment |
| Net cash flow | Total inflow minus total outflow for that month. Negative when more went out than came in |
| Opening balance | The cash the business holds at the start of the month |
| Closing balance | The cash it holds at the end of the month |
Net cash flow = total cash inflow - total cash outflow
Closing balance = opening balance + net cash flow
Opening balance of a month = closing balance of the month before
That third line is the one every completion question depends on. If any cell in a forecast is blank, one of these three relationships will fill it.
A worked forecast
A workshop starts January with $5,000 in the bank and plans to buy a machine for $12,000 in February.
| Item | Jan | Feb | Mar | Apr |
|---|---|---|---|---|
| Cash sales | 12,000 | 14,000 | 18,000 | 20,000 |
| Payments from credit customers | 6,000 | 6,000 | 6,000 | 8,000 |
| Total cash inflow | 18,000 | 20,000 | 24,000 | 28,000 |
| Materials | 8,000 | 9,000 | 10,000 | 11,000 |
| Wages | 7,000 | 7,000 | 7,000 | 7,000 |
| Rent and other overheads | 4,000 | 4,000 | 4,000 | 4,000 |
| New machine | 0 | 12,000 | 0 | 0 |
| Total cash outflow | 19,000 | 32,000 | 21,000 | 22,000 |
| Net cash flow | -1,000 | -12,000 | 3,000 | 6,000 |
| Opening balance | 5,000 | 4,000 | -8,000 | -5,000 |
| Closing balance | 4,000 | -8,000 | -5,000 | 1,000 |
Working the columns:
January: total inflow = 12000 + 6000 = $18,000. Total outflow = 8000 + 7000 + 4000 = $19,000. Net cash flow = 18000 - 19000 = -$1,000. Closing balance = 5000 + (-1000) = $4,000.
February: total outflow = 9000 + 7000 + 4000 + 12000 = $32,000. Net cash flow = 20000 - 32000 = -$12,000. Closing balance = 4000 + (-12000) = -$8,000.
March: total outflow = 10000 + 7000 + 4000 = $21,000. Net cash flow = 24000 - 21000 = $3,000. Closing balance = -8000 + 3000 = -$5,000.
April: total outflow = 11000 + 7000 + 4000 = $22,000. Net cash flow = 28000 - 22000 = $6,000. Closing balance = -5000 + 6000 = $1,000.
Completing and amending a printed forecast
Missing cells can sit anywhere, so learn to work in both directions.
Forwards. Opening balance $3,000, total inflow $14,000, total outflow $16,000. Net cash flow = 14000 - 16000 = -$2,000, so the closing balance = 3000 + (-2000) = $1,000, and next month opens on $1,000.
Backwards. A month opens on $3,000 and closes on $1,000, and the inflow is given as $14,000. The net cash flow must be 1000 - 3000 = -$2,000, so total outflow = 14000 + 2000 = $16,000.
Amending. Change one figure and everything below and to the right of it moves. If February wages rise by $1,000, February outflow becomes $33,000, February net cash flow becomes -$13,000, and every closing balance from February onwards drops by $1,000: February -$9,000, March -$6,000, April $0. Marks are lost here by changing February and leaving March and April untouched.
Interpreting a forecast
Say what the numbers mean for this business, not what the rows are called.
The workshop is not in trouble because it is unprofitable. Cash sales climb every month and by March the business is generating $3,000 more than it spends. It is in trouble because a $12,000 machine lands in a single month on a business holding $4,000, and it takes until April to climb back above zero. The negative closing balances in February and March mean the bank account is overdrawn, so the business needs an agreed overdraft of at least $8,000 or the payments will bounce.
Two habits earn the analysis marks. Quote the figure and the month together, because "the closing balance is negative in February and March" beats "the business has cash problems". And follow the shortage to a consequence: an unarranged overdraft means charges, refused payments, and suppliers demanding cash.
How to solve a short-term cash flow problem
| Method | How it works | The cost of it |
|---|---|---|
| Arrange an overdraft | The bank allows the account below zero up to an agreed limit, charging interest only on what is used | The dearest way to borrow, and repayable on demand |
| Delay paying suppliers | Take the full credit period, or ask for longer, so the outflow lands later | Lost discounts, and a supplier who may refuse further deliveries |
| Ask customers to pay more quickly | Shorten the credit period, or offer a discount for settling early | The discount cuts revenue, and customers who value credit go elsewhere |
| Delay the purchase of non-current assets | Push a planned machine, vehicle or fitting-out into a later month | The business works on with older equipment, and may lose the orders the new asset was bought for |
Delaying the asset purchase is the strongest option here, because it moves the exact figure causing the problem. Push the $12,000 machine from February to April and total outflow for the four months is unchanged at $94,000, but the timing is transformed: February outflow becomes $20,000 and net cash flow becomes $0, March closes on 4000 + 3000 = $7,000, and April outflow becomes 22000 + 12000 = $34,000, giving net cash flow of 28000 - 34000 = -$6,000 and a closing balance of 7000 - 6000 = $1,000. The business ends April on the same $1,000 and never goes overdrawn at all.
That comparison is what evaluation looks like on this topic. All four methods work on paper; the one to recommend is the one that fits the cause. A shortage caused by a single large purchase is fixed by moving the purchase. A shortage caused by customers taking 90 days to pay is not, and needs the credit terms tightened instead.
Common mistakes
- Treating the forecast as a statement of profit or loss. It records money moving, never gross profit, and a machine appears in full in the month it is paid for.
- Putting a credit sale in the month it was made instead of the month it is paid for.
- Adding the net cash flow of every month together to get the closing balance, instead of carrying the closing balance forward as the next opening balance.
- Forgetting the sign. A net cash flow of -$12,000 is subtracted from the opening balance, not added.
- Changing one figure after an amendment and leaving the later months alone.
- Saying a negative closing balance means the business is making a loss. It means the account is overdrawn.
- Answering "how could the problem be solved" with "sell more" or "cut costs". Those are long-term aims, not ways of moving cash into the month where it is short.
- Recommending a bank loan for a one-month gap, then paying interest on it for years.
What the syllabus asks for on this topicSyllabus points
Syllabus points
- Explain why cash is important to a business.
- Explain what a cash flow forecast is and why a business prepares one.
- Identify the main features of a cash flow forecast: cash inflow, cash outflow, net cash flow, opening balance and closing balance.
- Amend or complete a simple cash flow forecast.
- Interpret a simple cash flow forecast.
- Explain how a short-term cash flow problem may be overcome, using an overdraft, delaying supplier payments, asking customers to pay more quickly, and delaying the purchase of non-current assets.
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