Cash

1. Lecture 6
Importance of Cash Flows in Credit
Management

2. Lecture Review
We will be looking at the following:
• The importance of cash flows in the viability
of a company
• Cash flow forecasts, how to prepare one
and their importance for a business
• The origins of cash flow problems
companies face on a daily basis
• Ways that cash can be managed to
maximise a company’s cash flows
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3. Lecture Objectives
 By the end of this session, you will be able
to:
• Appreciate the importance of cash for any
business
• Identify the fundamental components of a
cash flow forecast and be able to produce
one
• Understand and comment on the reasons
behind cash flow problems
• Identify and apply solutions to cash flow 3

4. Business Cash Flows
• Movement of money within a business,
both income and expenditure
• Profits do not give a useful or
meaningful picture of a company’s
operations
• Cash flow problems are responsible for
over 78% of business failures within
their first year 4

5. Illustrated Cash Flow
O
P
E
R
A
T
I
O
N
Cash sales
Debtors
New Share Issues
Loan Capital
Creditors
Wages/Salaries
Overheads
Purchases of FA
Cash inflows Cash outflows
Investments
Dividends

6. Cash Flow Forecasting
• Primary tool in short-term financial
planning
• Identifies short-term financial
requirements and surpluses based on
companies’ budgeted activities
• Continuous activity, as budgets are
rolled forward over time (usually on a
monthly basis)
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7. Importance of Cash
Budgeting/Forecasting
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8. Preparation of a Cash Flow Forecast
• Forecast anticipated cash inflows
• Forecast anticipated cash outflows
• Determine net cash flows
• Calculate cumulative cash flows
• Review situation and act accordingly
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9. Example of a Cash Flow Forecast
• Based on realistic estimates
• Constantly monitored and updated
• No need to be overly complicated
◦ ‘What if’ analysis can be undertaken (more later)
http://www.businesslink.gov.uk/Finance_files/Cash_Fl
ow_Projection_Worksheet.xls
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10. Aims of Cash Budgeting
• Evaluate the performance of a business
• Assess a company’s liquidity
• Assess differences between reported and
forecasted cash flows
• Assess the effects of major transactions
in the year.
• Ensure that company’s overdraft facility
is sufficient to accommodate variations in
trading 10

11. Cash Flow Problems (1)
• Debtors
◦ Norm for firms to offer credit to their customers
◦ Good management system integrating cash
budgeting and cash flow forecasting
◦ Failure to pay back at the agreed time has an
impact on the cash position of the company
◦ Bigger companies ‘abusing’ smaller companies by
delaying payments
 Late Payment Interest Act
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12. Example of Effect of Debtors on Cash Flow
Month: Pre-start 1 2 3 4 5 6
Receipts
Cash sales 5,000 5,000 5,000 5,000 5,000 5,000
Collections from credit sales 4,000 4,000 4,000 4,000 4,000
Total Receipts 5,000 9,000 9,000 9,000 9,000 9,000
Payments
Cash purchases 2,500 2,500 2,500 2,500 2,500 2,500
Payments to creditors 2,500 2,500 2,500 2,500 2,500
Total Payments 2,500 5,000 5,000 5,000 5,000 5,000
Cashflow Surplus/Deficit (-) 2,500 4,000 4,000 4,000 4,000 4,000
Opening Cash Balance -5,000 -2,500 1,500 5,500 9,500 13,500
Closing Cash Balance -2,500 1,500 5,500 9,500 13,500 17,500
Month: Pre-start 1 2 3 4 5 6
Receipts
Cash sales 5,000 5,000 5,000 5,000 5,000 5,000
Collections from credit sales 2,000 1,500 1,350 1,000 3,350
Total Receipts 5,000 7,000 6,500 6,350 6,000 8,350
Payments
Cash purchases 2,500 2,500 2,500 2,500 2,500 2,500
Payments to creditors 2,500 2,500 2,500 2,500 2,500
Total Payments 2,500 5,000 5,000 5,000 5,000 5,000
Cashflow Surplus/Deficit (-) 2,500 2,000 1,500 1,350 1,000 3,350
Opening Cash Balance -5,000 -2,500 -500 1,000 2,350 3,350
Closing Cash Balance -2,500 -500 1,000 2,350 3,350 6,700
Debtors taking their time to pay
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13. Why Can Debtors Become a Problem?
• Debtors hold key to liquidity
◦ Stocks need to be turned into sales before
generating cash flows and
◦ Large cash balances are generally
unprofitable to hold
• Debtors are not turned into cash fast
enough because of:
◦ credit terms
◦ overdue situation(s)
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14. Cash Flow Problems (2)
• Creditors
◦ Taking credit is seen as “a good thing”
◦ Money stays in the firm for longer
◦ Pay suppliers later (?)
◦ Dependence on debtors paying on time
leads to firm failing to pay off its debt on time
(domino-effect)
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15. Example: Creditor Effect on Cash Flow
Month: Pre-start 1 2 3 4 5 6
Receipts
Cash sales 5,000 5,000 5,000 5,000 5,000 5,000
Collections from credit sales 4,000 4,000 4,000 4,000 4,000
Total Receipts 5,000 9,000 9,000 9,000 9,000 9,000
Payments
Cash purchases 2,500 2,500 2,500 2,500 2,500 2,500
Payments to creditors 2,500 2,500 2,500 2,500 2,500
Total Payments 2,500 5,000 5,000 5,000 5,000 5,000
Cashflow Surplus/Deficit (-) 2,500 4,000 4,000 4,000 4,000 4,000
Opening Cash Balance -5,000 -2,500 1,500 5,500 9,500 13,500
Closing Cash Balance -2,500 1,500 5,500 9,500 13,500 17,500
Month: Pre-start 1 2 3 4 5 6
Receipts
Cash sales 5,000 4,500 3,000 3,000 0 1,500
Collections from credit sales 2,000 1,500 1,350 1,000 3,350
Total Receipts 5,000 6,500 4,500 4,350 1,000 4,850
Payments
Cash purchases 2,500 2,250 1,500 1,500 0 750
Payments to creditors 2,500 2,250 1,500 1,500 0
Total Payments 2,500 4,750 3,750 3,000 1,500 750
Cashflow Surplus/Deficit (-) 2,500 1,750 750 1,350 -500 4,100
Opening Cash Balance -5,000 -2,500 -750 0 1,350 850
Closing Cash Balance -2,500 -750 0 1,350 850 4,950
Debtors taking their time to pay / Creditors taking action against the firm
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16. Cash Flows and Credit Terms
• Cash flows are also affected by changes in
their own credit terms
◦ Tighter debtor credit terms
◦ Looser debtor credit terms
◦ What about the terms offered by the
suppliers?
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17. Cash Flow Problems (3)
• Over-financing
◦ Borrowing excessive amounts of money leads to
financial difficulties
• Overtrading
◦ Expansion of sales on credit without enough
capital affects companies’ cash flows
• Over-investment
◦ Excessive investment in assets
• Poor stock control
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18. Managing Income and Expenses
 Debtor management
• Credit policy
• Efficient invoicing/collection
• Charging interest on late payments
• Offer of discount for prompt payments
• Negotiation of deposits or staged
payments
• Debt factoring and/or invoice discounting 18

19. Managing Income and
Expenses
 Creditor management
• Negotiation of extended credit terms
• Reduction of stock
• Leasing vs. buying an asset
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20. Optimisation of Cash Flow
• Optimisation of working capital
◦ Larger loan amounts when required
◦ Customers paying within credit terms
◦ Investors infusing money in the
business
• Decrease expenses
◦ Lower interest rates on loans and
premiums on insurance
◦ Better credit terms with suppliers
◦ Better lease rates on assets
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21. Sensitivity Analysis in Cash Flow
Forecasts
• Assumptions for analysing potential
effects of changes to forecasts
• Historical data on late payments
and/or bad debts used to analyse
different levels of debtors
• Analysis of results and identification of
risks associated
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22. Summary
• Cash is King! Without it, no company
can survive
• Credit management practices have a
direct impact on cash
http://www.morebusiness.com/running_your_
business/profitability/Business-Cash-Flow.brc
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