Cambridge Syllabus Notes

5.3 Forecasting and Managing Cash Flows – Cash‑Flow Forecasts

Objective

Students will be able to:

Explain why cash‑flow forecasts are prepared.
Read, interpret and amend a simple cash‑flow forecast.
Carry out scenario / sensitivity analysis.
Calculate the Cash‑Conversion Cycle (CCC) and suggest ways to shorten it.
Identify and evaluate a range of methods for improving cash flow, including short‑term financing.

5.3.1 Meaning & Purpose of a Cash‑Flow Forecast

Definition: A cash‑flow forecast predicts the timing and amount of cash inflows and outflows over a future period (usually a month, quarter or year).
Key purposes:
- Identify periods of cash surplus or deficit.
- Determine the amount (if any) of external finance required.
- Support decisions on pricing, production, inventory and cost control.
- Provide a basis for “what‑if” or sensitivity analysis.
- Link cash‑flow timing to working‑capital components (receivables, payables, inventory).

5.3.2 Structure of a Simple Cash‑Flow Forecast

A basic forecast contains three columns and three rows of balances for each period.

Cash Inflows – receipts from sales, collection of receivables, interest, loan proceeds, etc.
Cash Outflows – payments for purchases, wages, rent, interest, tax, loan repayments, etc.
Net Cash Flow – the difference between inflows and outflows.

Formulas (plain‑text version):

Net Cash Flow_t = Cash Inflows_t – Cash Outflows_t
Closing Balance_t = Opening Balance_t + Net Cash Flow_t
Opening Balance_t+1 = Closing Balance_t

5.3.3 How to Read a Cash‑Flow Forecast

Month	Cash Inflows ($)	Cash Outflows ($)	Net Cash Flow ($)	Opening Balance ($)	Closing Balance ($)
January	120,000	95,000	25,000	30,000	55,000
February	110,000	100,000	10,000	55,000	65,000
March	130,000	115,000	15,000	65,000	80,000

Interpretation steps

Check the Net Cash Flow for each period – a positive figure = cash surplus; a negative figure = cash deficit.
Verify that the Closing Balance of one month equals the Opening Balance of the next month.
Compare each closing balance with the business’s minimum cash reserve. Any balance below the reserve signals a potential financing need.

5.3.4 Amending a Forecast – “What‑If” Example

Scenario: The business negotiates a 10‑day extension on a £30,000 supplier invoice that would otherwise be paid in February.

Original February cash outflow = £100,000 (includes the £30,000 invoice).
After the extension, February outflow falls to £70,000; the £30,000 is added to March’s outflow.

Month	Cash Outflows ($)	Net Cash Flow ($)	Closing Balance ($)
February (amended)	70,000	40,000 (110,000 – 70,000)	95,000 (55,000 + 40,000)
March (amended)	145,000 (115,000 + 30,000)	-15,000 (130,000 – 145,000)	80,000 (95,000 – 15,000)

Result: the cash deficit is moved from February to March, giving the business an extra £40,000 of cash in February to meet short‑term obligations.

5.3.5 Scenario & Sensitivity Analysis – Worked Example

Assume the same three‑month forecast above. Two scenarios are examined:

Scenario	Assumption	Effect on Cash Inflows	Effect on Cash Outflows
Best‑case	Sales increase 10 %; inventory holding cost falls 5 %	+10 % to each month’s inflows	‑5 % to each month’s inventory‑related outflows
Worst‑case	Collections fall 15 %; operating expenses rise 8 %	‑15 % to each month’s inflows	+8 % to each month’s non‑inventory outflows

Best‑case recalculation (rounded)

Month	Cash Inflows ($)	Cash Outflows ($)	Net Cash Flow ($)	Closing Balance ($)
January	132,000 (120,000 × 1.10)	90,250 (95,000 × 0.95)	41,750	71,750 (30,000 + 41,750)
February	121,000 (110,000 × 1.10)	95,000 (100,000 × 0.95)	26,000	97,750 (71,750 + 26,000)
March	143,000 (130,000 × 1.10)	109,250 (115,000 × 0.95)	33,750	131,500 (97,750 + 33,750)

Worst‑case recalculation (rounded)

Month	Cash Inflows ($)	Cash Outflows ($)	Net Cash Flow ($)	Closing Balance ($)
January	102,000 (120,000 × 0.85)	102,600 (95,000 + 8 % of 95,000)	-750	29,250 (30,000 – 750)
February	93,500 (110,000 × 0.85)	108,000 (100,000 + 8 % of 100,000)	-14,500	14,750 (29,250 – 14,500)
March	110,500 (130,000 × 0.85)	124,200 (115,000 + 8 % of 115,000)	-13,700	1,050 (14,750 – 13,700)

Comment: In the best‑case the business ends the quarter with a large cash surplus, whereas in the worst‑case the closing balance falls to almost zero, indicating a need for external finance.

5.3.6 Methods of Improving Cash Flow (Syllabus References)

Method (Syllabus Ref.)	How It Improves Cash Flow	Potential Drawbacks
Accelerate Receivables – 5.3.2	Reduce Days Sales Outstanding (DSO); cash is received sooner.	Early‑payment discounts cut profit margin; may strain customer relations.
Delay Payables – 5.3.2	Increase Days Payable Outstanding (DPO); cash stays in the business longer.	Risk of damaging supplier relationships; loss of early‑payment discounts.
Inventory Management (JIT, ABC) – 5.3.2	Lower Days Inventory Outstanding (DIO); free cash tied up in stock.	Higher risk of stock‑outs and lost sales if inventory is too low.
Cost Control & Reduction – 5.3.3	Directly reduces cash outflows (fixed and variable costs).	May affect product quality, employee morale or long‑term growth.
Short‑Term Financing – 5.3.4	Provides immediate cash to bridge temporary deficits. Overdraft / Line of credit: flexible, interest charged only on the amount used. Factoring: sells receivables to a third party for an immediate cash advance (typically 70‑90 % of invoice value). Trade credit: supplier agrees to extend payment terms, effectively a short‑term loan.	Interest and fees increase overall costs; reliance on external finance can reduce financial independence; factoring may reduce profit on sales.
Cash‑Flow Forecasting & Monitoring – 5.3.1	Enables proactive management; early identification of shortfalls allows timely action.	Requires accurate, up‑to‑date data; can be time‑consuming for small firms.
Pricing & Sales Strategies – 5.3.5	Increase cash inflow per transaction (e.g., cash‑sale discounts, bundling, up‑selling).	May reduce demand if prices become uncompetitive; discounts cut profit margin.

5.3.7 Calculating the Cash‑Conversion Cycle (CCC)

The CCC measures the time (in days) that cash is tied up in the operating cycle.

Formula

CCC = DSO + DIO – DPO

DSO (Days Sales Outstanding) = (Average Trade Receivables ÷ Credit Sales) × 365
DIO (Days Inventory Outstanding) = (Average Inventory ÷ Cost of Goods Sold) × 365
DPO (Days Payable Outstanding) = (Average Trade Payables ÷ Purchases) × 365

Worked example

Item	Annual Figure ($)	Average Balance ($)	Days Calculation
Credit Sales	1,200,000	—	—
Trade Receivables (average)	—	100,000	DSO = (100,000 ÷ 1,200,000) × 365 = 30.4 days
Cost of Goods Sold	720,000	—	—
Inventory (average)	—	60,000	DIO = (60,000 ÷ 720,000) × 365 = 30.4 days
Purchases (annual)	720,000	—	—
Trade Payables (average)	—	80,000	DPO = (80,000 ÷ 720,000) × 365 = 40.6 days

CCC = 30.4 + 30.4 – 40.6 = 20.2 days. A shorter CCC means cash is recovered more quickly, improving liquidity.

5.3.8 Practical Steps for Students (Exam Checklist)

Identify the three cash‑flow drivers in the case study – receipts, payments and financing.
Calculate the current Cash‑Conversion Cycle using the CCC formula.
Suggest at least two methods to shorten the CCC (e.g., accelerate receivables, adopt JIT inventory). Explain the expected impact on cash inflows/outflows.
Amend the original cash‑flow forecast to reflect your suggested improvements. Show the revised “what‑if” figures and recompute opening and closing balances.
Prepare a brief scenario analysis (best‑case / worst‑case). Re‑calculate the forecast for each scenario and comment on how financing requirements change.
Conclude with a recommendation on the most appropriate short‑term financing option, if any, and justify your choice.

5.3.9 Diagram (Suggested)

Flowchart: Interaction between cash inflows, cash outflows, cash‑flow forecasting, the Cash‑Conversion Cycle and methods of improving cash flow.

different methods of improving cash flow