interpret a simple cash flow forecast

Topic 5.2.1 – The importance of cash and cash‑flow forecasts

Learning objective

Interpret a simple cash‑flow forecast, understand how it links to other financial information and how it satisfies the requirements of the Cambridge IGCSE/A‑Level Business Studies syllabus (Sections 5.1 – 5.5).

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1. Business finance: needs, sources and the link to cash‑flow forecasts (syllabus 5.1)

Why a business needs finance

• Start‑up capital – purchase of equipment, premises and initial stock.
• Working‑capital – day‑to‑day cash for suppliers, staff, rent, utilities, etc.
• Expansion / diversification – new product lines, larger premises, marketing campaigns.
• Unexpected events – fall in sales, rise in input costs, equipment breakdowns.

Typical sources of finance

Source	Internal / External	Typical cash‑flow entry
Retained profits	Internal	Cash inflow (owner’s reinvestment) – shown as “Equity injection”
Owner’s personal savings	Internal	Cash inflow – “Owner’s capital contribution”
Sale of non‑essential assets	Internal	Cash inflow – “Proceeds from asset sale”
Bank overdraft / short‑term loan	External	Cash inflow – “Bank borrowing” (repayment appears as cash outflow)
Long‑term loan or mortgage	External	Cash inflow – “Long‑term borrowing” (interest and principal repayments are outflows)
Equity finance (shares, partner)	External	Cash inflow – “Issue of shares / partnership capital”

When a cash‑flow forecast is prepared, each source of finance is recorded as a separate cash‑inflow (or outflow) line item, allowing the business to decide which source is most appropriate and when it will be needed.

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2. Why cash is vital for a business (syllabus 5.2)

• Cash is the lifeblood that enables a business to meet its day‑to‑day obligations.
• A profitable business can still fail if it cannot convert profit into cash quickly enough.
• Cash‑flow problems are one of the most common reasons for business failure.

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3. What is a cash‑flow forecast?

A cash‑flow forecast is a forward‑looking projection of the amounts of cash that will flow into and out of a business over a specified period (usually monthly). For each period it shows:

• Opening balance (cash on hand at the start of the period)
• Cash inflows (sales receipts, loans, asset sales, capital injections, etc.)
• Cash outflows (payments to suppliers, staff, rent, utilities, interest, tax, dividends, loan repayments)
• Net cash flow = Inflows – Outflows
• Closing balance = Opening balance + Net cash flow

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4. Preparing a cash‑flow forecast (syllabus 5.2)

1. 5.2.1 Identify cash‑inflows – sales receipts, loan proceeds, asset sales, equity injections.
2. 5.2.2 Identify cash‑outflows – purchases of stock, wages, rent, utilities, interest, tax, dividend payments, loan repayments.
3. 5.2.3 Determine the timing – when each receipt or payment is actually expected (e.g., credit sales collected in 30 days, quarterly tax payment).
4. 5.2.4 Make realistic assumptions – based on past records, market research, seasonality and any known changes in costs or prices.
5. 5.2.5 Link to the working‑capital cycle – the three components that affect cash flow:
   • Stock – cash is tied up when inventory is purchased.
   • Receivables – cash is delayed until customers pay.
   • Payables – cash is retained until the business pays its suppliers.

   Working‑capital cycle diagram (textual):
   Cash → Purchase stock → Store stock → Sell on credit → Receivables → Collect cash → Cash. Paying suppliers (payables) can be placed anywhere in the cycle to show the timing effect on cash.

6. 5.2.6 Calculate net cash flow and closing balance for each period.
7. 5.2.7 Use the closing balance as the opening balance for the next period.

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5. Simple cash‑flow forecast – Example 1 (Retailer)

Month	Opening Balance ($)	Cash Inflows ($)	Cash Outflows ($)	Net Cash Flow ($)	Closing Balance ($)
January	5,000	8,200	6,500	+1,700	6,700
February	6,700	7,500	9,200	–1,700	5,000
March	5,000	9,000	5,800	+3,200	8,200

How to interpret the forecast

1. Check the net cash flow for each month. Positive values = surplus; negative values = deficit.
2. Verify the closing balance calculation (Closing = Opening + Net cash flow). Example for February: 6,700 + (–1,700) = 5,000.
3. Identify any month with a cash deficit – February shows a deficit of $1,700.
4. Consider actions to cover the deficit:
   • Arrange a short‑term overdraft or bank loan.
   • Accelerate collection of receivables (e.g., early‑payment discount).
   • Delay non‑essential purchases or negotiate longer credit terms with suppliers.
5. Use surplus months (January and March) to:
   • Repay part of any borrowing.
   • Build a cash reserve for emergencies.
   • Invest in additional stock or equipment to support growth.

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6. Simple cash‑flow forecast – Example 2 (Seasonal business)

This example shows that a cash deficit can occur even when sales are high, because of the timing of stock purchases and tax payments.

Month	Opening Balance ($)	Cash Inflows ($)	Cash Outflows ($)	Net Cash Flow ($)	Closing Balance ($)
April (pre‑season)	4,000	2,000	5,500	–3,500	500
May (peak season)	500	12,000	8,000	+4,000	4,500
June (post‑season tax)	4,500	3,000	7,500	–4,500	0

Key observations

• April shows a large deficit because the business must buy stock before sales start.
• May generates a surplus, but it is largely absorbed by the tax payment in June, leaving a zero closing balance.
• Lesson: Even a highly profitable peak month may not prevent cash‑flow problems if outflows are poorly timed.

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7. Linking cash‑flow forecasts to other financial statements

7.1 Income statement (profit & loss account)

Profit is calculated on an accrual basis, whereas cash flow records only actual cash movements. The table below illustrates the difference using the data from Example 1.

Item	Accrual (profit) figure	Cash‑flow figure
Sales revenue (accrued)	$9,000	Cash received $9,000 (May)
Cost of sales (accrued)	($5,800)	Cash paid $5,800 (May)
Depreciation (non‑cash)	($800)	Not shown in cash flow
Net profit (accrual)	$2,400	Net cash flow (May) +$3,200

Even though profit is $2,400, the cash inflow for the month is $3,200 because depreciation does not affect cash.

7.2 Statement of financial position (balance sheet)

The closing cash balance from the forecast appears under “Cash and cash equivalents” on the balance sheet.

Balance Sheet (as at end of March)	Amount ($)
Non‑current assets (e.g., equipment)	15,000
Current assets
Stock	4,200
Debtors (receivables)	3,800
Cash & cash equivalents	8,200
Current liabilities	12,000
Non‑current liabilities	10,000
Equity	8,000

The cash balance ($8,200) is a key component of the firm’s liquidity.

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8. Ratio analysis using the cash‑flow forecast (syllabus 5.5)

8.1 Liquidity ratios

Ratio	Formula	Interpretation
Current Ratio	Current Assets ÷ Current Liabilities	Measures ability to meet short‑term obligations; a higher ratio indicates greater safety.
Cash Ratio	Cash & Cash Equivalents ÷ Current Liabilities	Most conservative measure – shows cash available to pay immediate debts.

Worked example – Cash Ratio

Using the closing cash balance from Example 1 (March = $8,200) and assuming current liabilities of $12,000:

• Cash Ratio = 8,200 ÷ 12,000 = 0.68

Evaluation: A cash ratio of 0.68 means the business has 68 cents of cash for every dollar of current liabilities. It can meet most short‑term debts, but it would still need to rely on other current assets (stock, receivables) to cover the remaining 32 cents.

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9. External influences and a forecast‑adjustment checklist (syllabus 6.1‑6.3)

Key external factors that affect cash flow

• Interest rates – Higher rates increase borrowing costs (interest outflows) and may reduce consumer spending.
• Tax policy – Changes in corporation tax or VAT rates alter cash outflows.
• Inflation – Raises the cost of stock and operating expenses, widening cash deficits.
• Exchange rates (import‑export businesses) – Affect the cash amount required for foreign purchases and the value of overseas receipts.

Forecast‑adjustment checklist

1. Identify any announced or likely changes in interest rates; adjust interest‑payment forecasts accordingly.
2. Check for upcoming tax‑rate changes or new tax legislation; revise tax‑payment timing and amounts.
3. Review inflation forecasts; increase projected cash outflows for stock, wages and utilities if inflation is expected to rise.
4. If the business trades internationally, monitor exchange‑rate forecasts and adjust cash inflows/outflows for foreign transactions.
5. Document each assumption change in a “Notes to the forecast” section for transparency and future review.

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10. Key points to remember

• Cash‑flow forecasts are forward‑looking tools that complement, not replace, actual cash records.
• Accuracy depends on realistic assumptions about sales, collections, payments and external factors.
• Regular updating (usually monthly) keeps the business on track and helps avoid unexpected cash shortages.
• Linking the forecast to the income statement, balance sheet and liquidity ratios provides a complete picture of financial health.
• Always consider external influences and record any adjustments made to the forecast.

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