Controlling cash flow

by The Times 100 on Monday 15th November, 2010

Profit is undeniably important in business. It is not only the incentive for business owners and shareholders to take the necessary risks to run the business, it enables reinvestment and growth. Profit on its own, however, is not enough to secure the future of organisations. Cash flow is necessary for survival. In the short term, cash can be considered more important than profit. If a firm does not have enough cash to pay its bills, then it will not survive very long. One of the roles of management accountants is to forecast, monitor and control cash flow in order to maintain financial health within their organisations, looking for imaginative ways to improve cash flow and manage credit. CIMA is the world's leading professional body of management accountants. CIMA-trained management accountants often hold senior management positions within businesses.

The Pontin's holiday camp company is a recent victim of the credit crunch and is suffering from cash flow problems. Last week it announced that it has been placed into administration although it will continue to trade as normal and no redundancies have yet been made. The chairman of Pontin's, Graham Parr, said that although the business was profitable it had gone into administration because its bank was no longer prepared to support its credit facilities. It is understood, however, that the bank has allowed Pontin's one year to find a buyer or additional sources of cash. The administrators are said to be optimistic that there was a future for the 'iconic British brand'. (BBC 13th November 2010)

Questions

  1. Define cash flow.
  2. Give examples of cash inflows and outflows for a business.
  3. Using the CIMA case study, suggest two ways in which a business could improve its cash flow situation.
  4. Analyse the benefits of effective cash flow forecasting.

Answers to questions

Define cash flow.

  • Cash flow refers to the movements of cash into and out of a business over a given period of time.

Give examples of cash inflows and outflows for a business.

  • Examples of cash inflows include sales of goods or services, loans, grants and sale of assets.
  • Examples of cash outflows include raw material costs, salaries, transport, rent and utility bills.

Using the case study, suggest two ways in which a business can improve its cash flow situation.

In simple terms, to improve cash flow then the cash inflows need to be increased or speeded up and the cash outflows need to be reduced or slowed down. This may be done by a variety of methods including:

  • making better use of assets
  • making sure as little interest is paid as possible on borrowing
  • negotiating payment dates with suppliers
  • chasing late payments from customers.

Analyse the benefits of effective cash flow forecasting.

Cash flow forecasts

  • identify periods of cash shortfall so action can be taken, e.g. arrange an overdraft, delay capital spending
  • identify periods of cash surplus so spending on expensive items can be scheduled for then
  • help organisations gain additional finance from lenders
  • reduce financial uncertainties.

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