Chapter 20 - Cash Flow Forecasting and Working Capital
Class Objective: To understand the difference between cash and profit
Cash is important to business. Fact!
Businesses need cash to pay wages, suppliers, utilities, etc...
Cash Flow Management, therefore, is a key element of business management. It is the process of making sure that there is enough cash within the company for paying its debts.
Is cash the same as profit, though?
Profit = Revenues - Costs
Cash refers to the money in and out used for paying expenses, costs, and even making investments;
Profit can be turned in to cash;
Retained Earnings = Cash.
Can a profitable business run out of cash?
Can an unprofitable business be 'cash-rich'?
Cash Flow Forecast helps the business to identify future cash inflows and outflows with the goal of preventing it from running out of cash at any given time.
Activity 20.1 (p. 260)
What happens when the business runs out of cash (closing balance zero or negative)?
Overdrafts (High interest)?
Loans (Interest)?
A better approach is to try to reduce outflows and increase inflows so that the problem doesn't even come to happen. Measures such as:
↓ Trade Receivables (early payment discounts);
↑ Trade Payables (suppliers trade credit);
Delay purchase of non-current assets;
Find other sources to finance non-current assets that are not cash (e.g. hire purchase, leasing, mortgage).
Sounds familiar?
Working Capital is the cash a business needs to remain liquid.
Liquidity is the ability of a business to pay its short-term debts;
A business that runs out of cash is considered insolvent;
Insolvent businesses that are unable to further finance their debts go into liquidation.
Activity 20.2 (p. 161)
But how much working capital/cash a business really needs to have in hands?
It all depends on the business' working capital cycle:
How much inventory the business keeps;
How quickly suppliers are paid (trade credit);
How long is the production process;
How easy/quickly it is to sell goods;
How long customers take to pay for the products they bought (trade credit).
Businesses willing to improve working capital and consequentially cash flow need to reduce the times for all the activities listed within the cycle.
Test Yourself (p. 262)
Activity 20.3 (p. 262)
Case Study - Metrorail (p. 263)
Test Yourself (p. 264)
Case Study - Shonaquip (p. 265)
To-Do-List:
Exam Style Questions (p. 266/267)
Chapter 20 - Cash Flow Forecasting and Working Capital
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