amend or complete a simple cash flow forecast

5.2.1 The Importance of Cash and Cash‑Flow Forecasts

Why cash‑flow forecasts matter

• Ensure the business can meet short‑term obligations (suppliers, staff, tax, loan repayments).
• Help avoid costly overdrafts, emergency borrowing or missed payments.
• Support decisions on investment, expansion, seasonal stock build‑up and working‑capital requirements.
• Provide evidence for lenders, investors and other stakeholders that the business is financially viable.
• Allow managers to test the impact of different scenarios (e.g., a 10 % drop in sales or a one‑off equipment purchase).
• Link directly to **working capital** – the cash needed to match short‑term inflows with short‑term outflows.

Cash‑flow forecast: definition and purpose

A cash‑flow forecast is a forward‑looking statement that records the expected cash receipts and cash payments for each period and shows the resulting cash balance. Its main purposes are to:

• Predict periods of cash surplus or shortage.
• Provide a basis for short‑term financing decisions.
• Assist in budgeting and strategic planning.
• Identify when corrective actions (e.g., delaying payments, arranging a loan, increasing sales effort) may be needed.

Key components of a simple cash‑flow forecast

Closing Balance = Opening Balance + Cash Receipts – Cash Payments

Assumptions and limitations

• Only cash transactions are recorded – credit sales or purchases are included only when cash is actually received or paid.
• Forecasts are based on assumptions (expected sales, payment terms, timing of receipts). If assumptions change, the forecast must be revised.
• A simple forecast does not show non‑cash items such as depreciation or accrued expenses.
• Accuracy depends on the quality of the information used (historical data, market research, supplier agreements, etc.).

Working capital (syllabus requirement 5.2.2)

Definition: Working capital is the amount of capital a business has available to meet its day‑to‑day operating expenses. It is calculated as:

Working Capital = Current Assets – Current Liabilities

Why it matters: Positive working capital indicates that a business can cover its short‑term liabilities with its short‑term assets, reducing the risk of cash shortages.

Simple numeric example (taken from a balance‑sheet excerpt):

Thus the business has £8,000 of working capital to fund its operating cycle.

Cash‑flow versus profit (AO4 point)

Profit shows how much a business earns after deducting expenses from revenue, but it does not indicate when cash actually moves in or out. Cash flow shows whether the business can pay its bills when they fall due, which is crucial for short‑term survival.

Amending or completing a simple cash‑flow forecast

Complete the three‑month forecast below. Some figures are given; calculate the missing values using the formula above.

Step‑by‑step guide

1. January: Closing Balance = 5,000 + 8,200 – 6,500 = 6,700.
2. February – opening balance: Use January’s closing balance → 6,700.
3. February – cash payments: Payments = Opening + Receipts – Closing = 6,700 + 7,400 – 4,900 = 9,200.
4. March – opening balance: Use February’s closing balance → 4,900.
5. March – cash receipts: Assuming the business wants a minimum closing balance of £2,300,
   Receipts = Closing – Opening + Payments = 2,300 – 4,900 + 5,200 = 2,600.
6. March – closing balance: Verify 4,900 + 2,600 – 5,200 = 2,300.
7. Check each month’s closing balance is positive. If any balance falls below the minimum cash reserve, possible actions include:
   • Arrange a short‑term loan or overdraft.
   • Delay non‑essential payments.
   • Accelerate collection of receivables.
   • Increase sales or introduce a promotional discount.

Diagram (suggested)

Flowchart: Opening Balance → + Cash Receipts → – Cash Payments → Closing Balance → (carry forward) Opening Balance of next month.

Common pitfalls to avoid

• Forgetting to carry the closing balance forward as the next month’s opening balance.
• Confusing cash receipts with total sales revenue that have not yet been received.
• Over‑estimating receipts or under‑estimating payments, creating an unrealistic surplus.
• Ignoring one‑off cash items (e.g., tax payments, equipment purchases) that can distort the forecast.
• Not stating the assumptions used (payment terms, expected sales growth, timing of collections).

Extension activity

The business expects a 15 % increase in cash receipts for April. Extend the forecast to include April using the same format. Show the impact on the April closing balance and discuss how the information could influence decisions about:

• Inventory levels – higher cash may allow a larger stock build‑up for the summer peak.
• Staffing – extra cash could fund temporary staff or overtime.
• Financing – a surplus might enable early repayment of a short‑term loan.

Summary checklist for exam questions

1. State the definition and purpose of a cash‑flow forecast.
2. List the four essential components (opening balance, receipts, payments, closing balance).
3. Write the core formula and show how to rearrange it for missing values.
4. Explain why cash flow is more important than profit in the short term.
5. Identify at least two actions a manager could take if a forecast shows a cash shortage.
6. Define working capital and give a simple numeric example.