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6.2.2 Completing and interpreting cash flow forecasts

6.2.2 Completing and interpreting cash flow forecasts

What a cash flow forecast shows

Definition

Cash flow forecast: a prediction of the cash expected to flow into and out of a business over a future period, set out month by month.

Cash inflow: money the business expects to receive, such as cash sales, payments from credit customers, a loan paid into the account or the proceeds of selling an asset.

Cash outflow: money the business expects to pay out, such as payments for stock, wages, rent, energy bills and loan instalments.

  1. The forecast reduces all of those expected flows to one figure per month, the cash the business expects to be holding when that month ends.
  2. You are not expected to build an entire forecast from scratch.
    1. You are given one with gaps, asked to complete those sections, and asked to say what the completed figures mean for the business.
  3. Only two calculations are needed to fill any gap, and both are worth learning by heart because they are not supplied for you.

How the forecast is laid out

  1. There is one column for each month, running left to right in time order, so January sits to the left of February.
  2. The top group of rows lists each expected inflow separately, such as cash sales and payments from credit customers, and those rows are added to give total cash in for the month.
  3. The next group lists each expected payment, such as stock, wages, rent and insurance, and those rows are added to give total cash out.
  4. Beneath them come three single rows in a fixed order: net cash flow, then the opening balance, then the closing balance.
  5. The closing balance at the foot of one column is copied straight into the opening balance at the head of the next, which is what chains the months together.

Working out net cash flow and the closing balance

Thornbury Tools, a hardware shop in Bristol, has forecast the next three months. Its individual inflows and outflows have already been added up, so the table shows the totals.

£JanuaryFebruaryMarch
Total cash in18,00012,00021,000
Total cash out15,50019,80016,400
Net cash flow2,500-7,8004,600
Opening balance4,0006,500-1,300
Closing balance6,500-1,3003,300
  1. Work down one column at a time, taking the top two rows as given and calculating the bottom three.
    1. February is the heavy month, because the annual insurance and a large stock order both fall due then.
Key Idea
  • These are the only two formulae you need, and neither is given to you in the exam.
net cash flow=total cash in−total cash out \text{net cash flow} = \text{total cash in} - \text{total cash out} net cash flow=total cash in−total cash out closing balance=opening balance+net cash flow \text{closing balance} = \text{opening balance} + \text{net cash flow} closing balance=opening balance+net cash flow
Example
  • January: total cash in is £18,000 against total cash out of £15,500, and Thornbury Tools starts the year holding £4,000.
net cash flow=£18,000−£15,500=£2,500 \text{net cash flow} = \pounds18{,}000 - \pounds15{,}500 = \pounds2{,}500 net cash flow=£18,000−£15,500=£2,500 closing balance=£4,000+£2,500=£6,500 \text{closing balance} = \pounds4{,}000 + \pounds2{,}500 = \pounds6{,}500 closing balance=£4,000+£2,500=£6,500
  • January is comfortable, because £2,500 more came in than went out and the bank balance grows from £4,000 to £6,500.
  • That £6,500 reappears at the top of the February column as its opening balance, which is what carries one month into the next.
Example
  • February: cash in drops to £12,000 while cash out jumps to £19,800, and the month opens on January's closing balance of £6,500.
net cash flow=£12,000−£19,800=−£7,800 \text{net cash flow} = \pounds12{,}000 - \pounds19{,}800 = -\pounds7{,}800 net cash flow=£12,000−£19,800=−£7,800 closing balance=£6,500+(−£7,800)=−£1,300 \text{closing balance} = \pounds6{,}500 + (-\pounds7{,}800) = -\pounds1{,}300 closing balance=£6,500+(−£7,800)=−£1,300
  • A closing balance of -£1,300 means Thornbury Tools expects to be £1,300 short, so it cannot pay all of February's bills from its own money.
  • The January cushion of £6,500 absorbs most of the £7,800 gap but not all of it.
  • The owner must arrange an overdraft, delay a payment or bring cash in sooner before February arrives.
Example
  • March: trade recovers to £21,000 in against £16,400 out, and the month opens on February's closing balance of -£1,300.
net cash flow=£21,000−£16,400=£4,600 \text{net cash flow} = \pounds21{,}000 - \pounds16{,}400 = \pounds4{,}600 net cash flow=£21,000−£16,400=£4,600 closing balance=−£1,300+£4,600=£3,300 \text{closing balance} = -\pounds1{,}300 + \pounds4{,}600 = \pounds3{,}300 closing balance=−£1,300+£4,600=£3,300
  • Reading the closing balance row across the table tells the story in one line: £6,500, then -£1,300, then £3,300.
  • The shortage was a one-month timing gap rather than a failing business, so a short overdraft covering February would have been enough, because the cash to repay it arrives in March.
Common Mistake
  • Adding a negative net cash flow makes the closing balance smaller, and losing the minus sign is the most common slip on these questions.
  • One wrong balance corrupts every later month, because it is carried forward as the next opening balance, so check each figure before you use it again.
  • A negative net cash flow is not a loss, because the forecast tracks the movement of cash rather than revenue against costs.

Filling in a missing figure

  1. Add an April column to the table above, with total cash in of £19,000, a closing balance of £5,000, and the opening balance of £3,300 carried down from March.
    1. The net cash flow and total cash out rows are blank, so rearrange the two formulae to fill them.
Example
  • April: rearranging the closing balance formula gives the net cash flow from the two balances you already have.
net cash flow=closing balance−opening balance \text{net cash flow} = \text{closing balance} - \text{opening balance} net cash flow=closing balance−opening balance net cash flow=£5,000−£3,300=£1,700 \text{net cash flow} = \pounds5{,}000 - \pounds3{,}300 = \pounds1{,}700 net cash flow=£5,000−£3,300=£1,700
  • With the net cash flow known, the same move on the other formula gives total cash out.
total cash out=total cash in−net cash flow \text{total cash out} = \text{total cash in} - \text{net cash flow} total cash out=total cash in−net cash flow total cash out=£19,000−£1,700=£17,300 \text{total cash out} = \pounds19{,}000 - \pounds1{,}700 = \pounds17{,}300 total cash out=£19,000−£1,700=£17,300
  • April is forecast to add £1,700 to the bank on payments of £17,300, so the recovery that began in March continues and the balance climbs to £5,000.
  • The owner can now plan the summer stock order knowing there is cash to fund part of it.

Interpreting the completed figures

  1. Read the two rows differently, because net cash flow describes only that month while the closing balance describes the position the business has reached overall.
  2. A month can have a negative net cash flow and still end with a positive closing balance, as long as the opening balance is large enough to absorb it, which Thornbury Tools came close to managing in February, where the £6,500 it opened with covered all but £1,300 of the £7,800 gap.
  3. A negative closing balance is the serious signal, because it means the business runs out of money that month and cannot pay its bills without finance from outside.
  4. One negative month between two positive ones points to a timing gap that an overdraft can bridge, while several negative months in a row point to a business spending more than it earns, which borrowing will not cure.
    1. Currys shows the same pattern on a far larger scale, because it buys and stores stock through the autumn for a Christmas the customers have not paid for yet, so its outflows run ahead of its inflows and the balance dips before December pulls it back up.
  5. Closing balances that shrink month after month are a warning even while they stay positive.
  6. The whole forecast rests on estimates, so an optimistic sales prediction can hide a shortage that arrives anyway.
Note

What the business should actually do about a negative closing balance is covered in the article on solutions to cash flow problems.

Exam technique

When asked to interpret the forecast, name the month and quote the balance, so write that the closing balance falls to -£1,300 in February rather than that cash gets tight.

Self review
  • State the formula for net cash flow and the formula for the closing balance.
  • Where does a month's opening balance come from?
  • If the opening balance is £800 and net cash flow is -£1,200, what is the closing balance?
  • How do you find total cash out when you know total cash in and net cash flow?
  • Using the table, why does March open on a negative figure?
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6.2.2 Completing and interpreting cash flow forecasts Revision Guide

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  3. /6.2.2 Completing and interpreting cash flow forecasts

Revision notes for AQA GCSE Business 6.2.2 Completing and interpreting cash flow forecasts: explanations and worked examples.