Cash Flow Forecasts: The Importance of Cash (22.1)

Thiago Casarin Lucenti

5 days ago

2 min read

Updated: 2 days ago

Chapter 22 - 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.

Think about it...

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 22.2

What happens when the business runs out of cash (closing balance zero or negative)?

Overdrafts (High interest)?
Loans (Interest)?

Possible, but 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).

All of the above options have consequences to be considered!

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.

Case Study 22.1 - Jet Airways

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.