Cash Flow
Business Management: IB Diploma, topic 3.5.1
Cash Flow
Cash is the money that a business can spend immediately (it doesn't include money that a business owes or is owed). Cash flow is the amount of money that is coming in and out of a business and the timings of these cash transfers.
Cash inflows
- Cash inflows is the cash coming into the business.
Cash outflows
- Cash outflows is the cash going out of the business.
Net cash flows
- Net cash flows is equal to cash inflows minus cash outflows.
Opening balance
- Opening Balance is the amount of cash that the business starts to trade with.
- A negative net cash flow may not create a liquidity problem if the business has a high opening cash balance.
Closing balance
- Closing balance – the amount of cash that a business finishes trading with.
Cash Flow Forecasts
Cash flow forecasts are a business’ prediction of how much money will come in and out of the business in a given amount of time.
Cash flow forecasts
- Businesses will estimate all the possible sources of cash inflows (e.g. sales) and cash outflows (rent, salaries, costs of production).
- They may be able to forecast these inflows and outflows using past data on sales and costs, as well as using market research.
Forecasting liquidity problems
- It is important for businesses to forecast this accurately to avoid liquidity problems.
- A liquidity problem is when a business runs out of cash in the short-term. They won’t have enough cash to pay rent and peoples’ wages.
- To solve a liquidity problem, a business has to reduce (or delay) cash outflows and increase (or get sooner) cash inflows.
Consequences of Cash Flow Problems
A business having persistent negative cash flows is unlikely to be sustainable. The business will eventually run out of money and will not be able to pay for salaries, rent or raw materials. In the short-term, negative cash flows can cause problems with stakeholders:
Employees
- If a firm runs out of cash, it may be unable to pay its employees.
- If employees are worried about cash, this can have a negative impact on employee motivation and they may leave the firm.
Suppliers
- If a business runs out of cash, it may not be able to pay its suppliers.
- This could create a temporary halt (stop) in production. It may also damage the relationship between the business and suppliers.
Creditors
- Creditors are organisations (or people) that have loaned a business money. If a business runs out of cash, it may not be able to repay these loans.
- If this happens, the business may not be able to get loans (finance) in the future or it may pay a higher interest rate.
Test yourself on Cash Flow
What is closing balance?
How can businesses solve liquidity problems?
What can businesses avoid by forecasting cash flow accurately?
How can businesses forecast cash inflows and outflows?
If a company runs out of cash, who might they be unable to pay?