Cash Flow Forecasts (Cambridge (CIE) A Level Business): Revision Note

The meaning and purpose of cash flow forecasts

• A cash flow forecast is a prediction of the anticipated cash inflows and outflows, usually for a six- to twelve-month period

  • Cash inflows include income from sales, loan sums received from the bank, interest received or capital injected into a business by owners

  • Cash outflows include payments for stock, staff wages and salaries, rent and utility bills and repayments of bank loans

• A detailed business plan usually includes a cash flow forecast

  • It provides evidence for investors or lenders that finance is required

  • It allows owners or managers to make plans to cover cash shortfalls

• Cash flow forecasts are particularly useful in the following situations:

  • Starting up a business

    • Identifying how much cash is needed in the first few months

  • Running an existing business

    • Recognising where a fall in sales may require use of an overdraft facility

  • Supporting applications for borrowing

    • Determining the size of loan or overdraft needed, when and for how long it is needed and by when it is likely to be fully repaid

  • Managing transactions

    • Identifying how much or how little cash is deposited at the bank can determine when bills should be paid

Interpreting cash flow forecasts

• The cash flow forecast structure

  • Compiles expected cash inflows and cash outflows, month by month,

  • Takes into account cash present at the beginning of the period

  • Determines the cash flow position at the end of each month over a period of time

• Although the layout can vary, a typical cash flow forecast includes each of the key elements

Example three-month cash flow forecast

Key terminology

• The opening balance is the cash position at the beginning of each month

  • In the first month, this is usually

    • Cash carried forward from any earlier trading

    • Cash introduced by the owner or from loans received

  • In later months, the opening balance is the closing balance carried forward from the previous month

• Net cash flow is the difference between cash inflows and cash outflows during a month

Calculating net cash flow

• The closing balance is the sum of the month's net cash flow and the opening balance

  • The closing balance is calculated using the formula

Calculating and amending cash flow forecasts

• A business must first gather information about all cash inflows and cash outflows it expects to encounter over the period

• The following steps should then be taken to construct the cash flow forecast

Step 1: Calculate total cash inflows

• In this instance, the business expects to receive cash inflows from sales in March, April and May

• Owners' capital of €6,000 will be introduced in March

• The total for each month is calculated by adding cash from sales to capital introduced

Step 2: Calculate total cash outflows

• In this instance, the business expects to pay rent of €1,400 in March, April and May

• It will purchase a significant amount of stock in March, with smaller amounts in April and May

• Wages are expected to be €2,100 in each month

• Utilities of €460 will be paid in March and April, increasing to €480 in May

• Total cash outflows each month is calculated by adding these together

Step 3: Calculate net cash flows

• Net cash flow is calculated by subtracting total cash outflows from total cash inflows

• In March the net cash flow is €10,500 - €10,760 = €(260)

  • Net cash flow is negative as cash outflows are greater than cash inflows

• In April the net cash flow is €4,800 - €4,560 = €240

• In May the net cash flow is €5,300 - €4,780 = €520

  • In both months, net cash flow is positive as cash inflows are greater than cash outflows

Step 4: Calculate opening and closing balances

• The opening balance is the previous month’s closing balance carried forward

• The closing balance is calculated by adding the net cash flow to the opening balance

• In March the opening balance of €0 is added to the net cash flow of €(260) to leave a closing balance of €(260)

• In April the closing balance from March is carried forward to become its opening balance of €(260) 

• This opening balance is added to April's net cash flow of €240 to leave a closing balance of €(20)

• In May the closing balance from April is carried forward to become its opening balance of €(20)

• This opening balance is added to May's net cash flow of €520 to leave a closing balance of €500

The complete cash flow forecast

• Overall, this cash flow forecast shows low cash inflows and significant outflows initially, which lead to negative net cash flow in March and April

• Healthy sales mean that from April, inflows are greater than outflows and the business has a positive net cash flow

Amending cash flow forecasts

• Cash flow forecasts can be amended if cash inflows or outflows are predicted to change

  • Each change will have an impact on the period's total inflows or outflows, net cash flow, closing balance and the subsequent opening balance

Methods of improving cash flow

• The best way to improve cash flow is to manage the business better

  • Identify potential cash flow issues before they arise and take appropriate action

  • Budget effectively and consider adopting zero budgeting to carefully control spending

  • Set clear financial objectives and look for ways to reduce outflows and increase inflows wherever possible

    • E.g. global conglomerate 3M, maker of Post-it notes, announced in early 2023 that it intends to raise prices and cut about 6,000 jobs to improve its profits and cash flow position 

• A business can also have too much cash

  • If a business is holding large amounts of cash, it is likely to be missing out on the benefits of investing it in fixed assets or investments

  • This may represent a significant opportunity cost, especially when interest rates are high

Methods to improve cash flow