Unit 5: Finance - Cash and Cash Flow
Toys R Us collapsed in the UK despite having £90 million worth of stock in their stores. The problem wasn't a lack of assets or potential profit - it was a lack of cash. They couldn't pay their suppliers or staff wages because customers weren't buying quickly enough to generate the cash needed. This demonstrates that even with valuable stock (an asset), without cash flow, a business cannot survive.
Cash is the money a business has available in the bank or as physical notes and coins. It can be used immediately to pay for things.
Profit is the surplus that remains after total costs have been deducted from total revenue. It's calculated as: Revenue - Costs = Profit
The Green Fork restaurant in Manchester made £8,000 profit in January. However, they had no cash available because: they offered 30-day credit terms to corporate customers for large bookings (£6,000 not yet received), they purchased new kitchen equipment for £4,000, and they paid back £2,000 of a bank loan. Despite being profitable on paper, they struggled to pay suppliers until customer payments arrived.
A cash flow forecast is a financial planning tool that predicts the cash inflows and outflows for a business over a future period (usually 12 months, broken down by month).
SunnyCone Ice Cream in Bournemouth creates a cash flow forecast each January. They know that their busiest months are June-August, but they need to pay suppliers and rent during the quieter winter months. By forecasting a cash deficit in February (£3,000 short), they arranged a £5,000 overdraft facility with their bank in advance. This prevented them from bouncing payments to suppliers and maintained good relationships. Additionally, they used the forecast to delay ordering a new freezer (costing £2,500) from January until June when they knew cash inflows would be stronger. This planning meant they could make the purchase without needing to borrow additional money.
A cash flow forecast has three main sections:
| Section | January (£) | February (£) | March (£) |
|---|---|---|---|
| Opening Balance | 5,000 | ? | ? |
| Cash Inflows (receipts from customers) | 12,000 | 10,000 | 15,000 |
| Cash Outflows (payments to suppliers, wages, etc.) | 14,000 | 11,000 | 13,000 |
| Net Cash Flow (Inflows - Outflows) | -2,000 | ? | ? |
| Closing Balance (Opening + Net Cash Flow) | 3,000 | ? | ? |
Remember: The closing balance always carries forward to become the next month's opening balance.
A negative net cash flow means the business spent more than it received in that month.
Even though net cash flow is negative, the closing balance is still positive because there was enough cash at the start of the month.
A positive net cash flow means the business received more cash than it spent in that month.
The business has improved its cash position from £3,000 in January to £4,000 by the end of March.
A cash flow problem occurs when a business does not have enough cash available to meet its immediate financial obligations, such as paying suppliers, wages, rent, or other bills. This can happen even if the business is profitable.
Businesses can reduce the time they give customers to pay from, for example, 60 days to 30 days. This means cash comes into the business sooner. However, some customers might prefer to buy from competitors who offer longer credit terms.
By actively contacting customers who haven't paid on time, businesses can speed up cash inflows. This might involve phone calls, reminder letters, or offering small discounts for early payment. However, this can be time-consuming and might damage customer relationships if done too aggressively.
If suppliers agree to wait longer for payment (e.g., extending from 30 to 60 days), the business keeps its cash for longer. This delays cash outflows and improves the cash position. However, suppliers might refuse or charge higher prices, and damaging supplier relationships could cause future problems.
An overdraft allows the business to spend more money than it has in its bank account, up to an agreed limit. This provides a safety net during months with negative cash flow. However, overdrafts charge interest, which increases costs, and banks can demand repayment at any time.
If a business was planning to buy equipment, vehicles, or machinery, postponing this purchase until cash flow improves prevents a large cash outflow. However, this might mean the business cannot expand or improve efficiency as quickly as planned.
Holding less stock means the business ties up less cash in unsold goods. The money saved can be used to pay bills instead. However, having too little stock might mean the business cannot fulfill customer orders, leading to lost sales.
Leasing equipment (paying a monthly rental fee) rather than buying it outright avoids a large one-off cash payment. This spreads the cost over time. However, leasing is usually more expensive in the long term than buying outright.
Urban Coffee in Bristol faced cash flow problems in winter when customer numbers dropped. They had a closing balance of -£1,800 in January and struggled to pay their coffee supplier. To solve this, they: (1) negotiated with their supplier to extend payment terms from 30 to 45 days, giving them an extra two weeks to collect cash from customers, (2) reduced their food stock levels by 30%, freeing up £600 that had been tied up in ingredients, and (3) arranged a £3,000 overdraft facility with their bank as a safety net. These combined actions improved their cash position and allowed them to continue trading through the quiet winter period.
TechPrint Solutions is a small printing business in Leeds that has been trading for three years. The business specialises in printing marketing materials for local companies. Currently, TechPrint has a closing cash balance of -£2,400 at the end of March, meaning they are relying on an overdraft facility of £5,000 provided by their bank.
The owner, Sarah, is concerned about the negative cash position and is considering two options to improve cash flow:
Option 1: Reduce the credit terms offered to customers from 60 days to 30 days. Currently, many customers take the full 60 days to pay, which means TechPrint often waits two months to receive cash for work completed. This delay creates significant cash flow problems. However, Sarah worries that some larger corporate clients might take their business to competitors who offer longer credit terms.
Option 2: Arrange a larger overdraft facility with the bank, increasing it from £5,000 to £10,000. This would cost an additional £45 per month in interest charges but would provide a bigger safety net for periods of negative cash flow. Sarah knows this wouldn't solve the underlying problem but would give the business more breathing room.
You should consider both options and make a justified recommendation.
Reducing credit terms from 60 to 30 days would help TechPrint because customers would pay one month earlier. This is important as they currently have a closing balance of -£2,400, so getting cash sooner would reduce time in overdraft and lower interest charges. However, Sarah is right to worry about losing corporate clients who expect longer payment terms.
Increasing the overdraft to £10,000 would give TechPrint more flexibility when cash flow is negative. Since they're already at -£2,400 with a £5,000 limit, they're using nearly half their overdraft. A bigger facility would provide more room for unexpected costs. However, this costs an extra £45 per month (£540 per year) and doesn't fix the actual problem.
Overall, TechPrint should reduce credit terms to 30 days because this solves the root cause - the long wait for customer payments. The larger overdraft just masks the problem and costs £540 annually. Most printing businesses offer 30-day terms anyway, so TechPrint would be matching competitors rather than disadvantaging themselves. Fixing the payment timing is better than paying more to borrow.
AO2 Application (2 marks): ✓✓ Both marks awarded. Clear application in both arguments – references the -£2,400 closing balance, the 60 to 30 day reduction, £5,000 limit, and the £45 monthly cost calculated to £540 annually.
AO3A Analysis (2 marks): ✓✓ Both marks awarded. Chains of reasoning present: "customers would pay one month earlier... reduce time in overdraft... lower interest charges." Second chain: "using nearly half their overdraft... provide more room for unexpected costs."
AO3B Judgement (3 marks): ✓✓✓ All three marks awarded. Clear judgement made (reduce credit terms), applied comparison using case study evidence (root cause vs masking problem), and weighted reasoning comparing £540 annual cost against solving payment timing. Reference to industry standards strengthens the judgement.
Reducing credit terms from 60 to 30 days means TechPrint would get money from customers one month earlier. Since they have a closing balance of -£2,400, getting paid sooner means less time in overdraft, which reduces interest charges. This would save the business money.
Increasing the overdraft from £5,000 to £10,000 gives TechPrint more money if they have cash flow problems. They're currently at -£2,400, so they're using nearly half their overdraft already. A bigger overdraft means more room if things get worse, but it costs £45 per month extra (£540 per year).
TechPrint should reduce credit terms to 30 days because this fixes the actual problem rather than just making the overdraft bigger. The problem is customers taking 60 days to pay, so reducing this to 30 days means cash comes in faster. The larger overdraft costs £540 per year and doesn't stop the long wait for payments. Reducing credit terms solves the root cause.
AO2 Application (2 marks): ✓✓ Both marks awarded. Application present in both arguments - references the -£2,400 closing balance, reduction from 60 to 30 days, "nearly half their overdraft already", and £45 monthly cost calculated to £540 annually.
AO3A Analysis (2 marks): ✓✓ Both marks awarded. Chains of reasoning present: "get money from customers one month earlier... less time in overdraft... reduces interest charges... save the business money." Second chain: "using nearly half their overdraft already... more room if things get worse."
AO3B Judgement (3 marks): ✓✓✓ All three marks awarded. Clear decision made (reduce credit terms), applied reasoning referencing the 60-day payment problem and -£2,400 position, and weighted comparison contrasting "fixes the actual problem" vs "making the overdraft bigger" and comparing the £540 annual cost against solving the root cause.
Note: This response is more concise and uses simpler language than Response A, but still meets all assessment criteria. It demonstrates that full marks can be achieved with straightforward writing in realistic timed conditions.
Complete the cash flow forecast below by calculating the missing values. Enter your answers and click "Check Answers" to see if you're correct.