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cash flow forecast

In this assignment I will be writing notes to accompany the cash flow forecast. I will be explaining to Sharma and Ryan why a business in general might experience cash flow problems, why this can cause difficulties and any potential dangers I can see specific to SIGNature’s cash flow forecast. What is a cash flow and the purpose of it?

A cash flow is a measure o the money coming into the business and the money going out of the business on a regular basis. A cash flow forecast predicts in advance what the inflows and outflows might be. It is vital for every business to have a healthy cash flow for survival. It provides information about the business’s gross receipts and payments. Receipts are the money that is received by the business by the owner, investors, customer sales and payments are the money that is spend by the business on as a capital and revenue expenditure. The cash flow statement doesn’t just include investing, and financing activities it also includes the amount of interest paid, the amount of income taxes paid, and any significant investing and financing activities which did not require the use of cash. General cash flow problems

Any business can experience cash flow problem depending on their cash inflows and outflows. A business might find it difficult to pay its revenue expenditures if their revenue income is low or decreasing. If the business’s outflows are greater than their opening balance and the inflows problems may occur resulting in a negative closing balance for that particular month. This is a problem as the business will not be able to make payments. They might fail to look at their financial statements until problems become too huge to handle. They might be spending more than they are earning for example making large payments for new materials, equipment when there is a seasonal drop in their sales. Some new businesses may experience cash flow problems because they have yet to build up reserves owned by their business. Other reasons might involve the business not making enough profit or low profit over investment, buying too much stock in advance, and allowing customers too much credit on their purchases and seasonal drop in sales. Overtrading can also be a cause of cash flow problems because if a business is opening too many new stores in a short period of time they will soon run out all cash as the stores might not be generating enough cash so fast.
Other factors involve-

•Lack of understanding of financial statements
•Lack of understanding od accurate and timely financial statements •Low gross profit due to high cost or not charging enough for products and services provided •Excessive interest on loans
•Maintenance of vehicle- insurance, road tax, fuel etc.
•Undisciplined spending
•Poor stock management
•Poor stock purchase
•Poor performance
•Lack of productivity
Difficulties and potential dangers
This may cause difficulties for the business as they will not have enough cash to make payments that are due. They will not be able to pay utility bills on time and therefore interest will be added onto their bills for late payments. They will struggle to buy goods from their suppliers as they won’t have sufficient cash for the purchase. The business will fail to pay its employees their wages and therefore may lose employees. This can ultimately result in the business making even less profit due to having insufficient members of staff to provide service to their customers. They may find it difficult to pay their insurances for example a business may have these insurances for the safety of the business and its employees- http://www.simplybusiness.co.uk/insurance/

•Public liability insurance
•Professional indemnity
•Employers liability
•Business building insurance
•Business equipment
•Tool cover
•Stock insurance
•Other insurances
If the business does not have sufficient amounts of money to pay these insurances they may find themselves in debt. If the business owns one or more vehicles and are unable to pay for its fuel, insurance and road tax they may be unable to own the vehicle therefore may have to sell it. The business may have asked for a loan from a bank and if they are short of money they won’t be able to pay the bank back its loan with interest which can result in the business being in debt with the bank. Purchase off extra stock in advance is good for every business however it can also be dangerous if their products aren’t selling well and promptly. This can result in the business paying for the extra stock form its capital income instead of its revenue income which is not healthy for the business. Some businesses face cash flow problems due to the business not charging enough for the products and services they provide. This means that the business is spending more on stock than making profit from sales. Other factors of cash flow problems may include the lack of productivity and performance of the employees which may result in the business not noticing many issues which can later on affect the business in the long run.

Potential dangers specific to SIGNature’s cash flow forecast

The most important issue is the closing balance of the months January to April They closing balance is negative for these four month therefore the opening balance from march to May will be very low and money will have to be loaned from the bank or personal money of the owners will be used. This is unhealthy for the business as they might get into a debt, there might be not enough cash in the business to pay bills and wages. Business will be struggling for those 4 months.

At the moment SIGNature is only using £20,000 in January for the fixtures and fitting. However if they needs more fixtures and fittings later on in the year they will be spending more than estimated on their cash flow forecast.

Here is an example of a problem-

By increasing the amount of fixtures and fittings needed in this year (June and July) the closing balance has now become negative for June and July. Therefore the opening balance for the month august has also become negative
(-£2,504) resulting in the business having no cash in the business for buying stock, paying bills, wages and other payments in August. However the business still has to pay its revenue expenditure even if it means that they have to get a loan from the bank, get an overdraft or the owners/ investor having to spend their personal money. SIGNature will have to use its capital income to pay for its revenue expenditure in order to cover all the payments of July and August. This can cause the business’s capital income to be spent on revenue expenditure rather than capital expenditure which is the initially what the capital income is used for. Signature has to make sure they have enough cash from overdraft or loans in order to cover up for the months July and August when they are out of cash. If they can keep their business running smoothly for these two months then they can get back on track from September as their opening balance will return back to being positive again meaning that the business will have cash in the business from September.

New problems can occur connecting to existing cash flow problems such as- loan repayment increasing as extra loan has been taken out from the bank.

Due to an extra amount of money being spent on fixtures and fittings in the months June and July, the business will have to take a loan out from the bank in July and August in to have enough cash for payments and wages for these two months. This problem has occurred because their closing balance for the months June and July has decreased due to extra costs on fittings and fixtures which has resulted into having a negative opening balance in July and August. Although the initial loan from the bank was £60,000 in January, the loan re-payment has been fixed to £1000 every month for as long as the loan wasn’t completely paid back. However since the business has to take out an extra loan of £2000 in July and £5000 in August due to having a negative opening balance , their loan re-payments will also increase. This is because the loan of £7000 in total in July and August is a different loan and separate from the loan of £60,000 in January therefore it cannot be repaid with a £1000 every month. This loan of £7000 has to be paid back in August and September as approved by the bank with the business because the loan was taken out under a short period of notice and must be paid back in a month’s time. Therefore the loan of £2000 taken out to cover July will be paid back in August with an interest added to it which makes it a total of £3525 to be repaid to the bank in August and £6766 to be paid back in September. Although the problem of extra expenditure can be covered by taking put a loan, other types of extra expenditure may rise and therefore create more problems.

An example for another vital expenditure might be buying new machinery or repairing existing ones if damaged.

So far through the first year since the establishment of the business, SIGNature has spent £85000 on their initial machinery however it does not mean that they won’t require any new machinery or that their machines would still be in perfect conditions. Therefore buying more machinery could turn vital. If SIGNature was to spend an extra £25000 on machinery in September which is nearly the end of their first year; they would find themselves being out of cash for bills and wages from October till December that same year. As figured on the cash flow chart above, the closing balance of September dropped from £9837 all the way down to -£15163. This has resulted in a negative opening balance of -£15163 in the start of October. This trend is carried on throughout the year as the opening balance cannot be positive unless the closing balance of each month is positive. This problem wouldn’t have occurred if SIGNature didn’t spend £85000 on machinery on January. They could have split it into 12 months and buy the basic machinery in January. The best way to solve this problem would be by spending less money on machinery in January as it is only the first month of the business and SIGNature might need to buy specific types of machinery according to the business’ progression. Instead of spending £8500 in January on machinery they could spend £55000 the first month, £5000 in February and £10000 in April. This way they will be spending £70000 on machinery instead of £85000n however this will allow them to spend an extra £25000 in September when buying machinery is vital for them in order to upgrade.

This way they can also manage to have a positive closing balance from the first month till the end of the year which wasn’t possible if they spent
£85000 on machinery in January.

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