Cashflow Forecasts

“Great news!” announced my Finance Director in our last board meeting, “last month we had a record level of invoiced sales”. “That’s fantastic” I said, “let’s pay a big bonus to everyone to celebrate.” “We can’t do that” she quickly replied, “we haven’t got enough cash in the bank. Most of those sales haven’t actually been paid for yet.”

Cashflow Forecasts

“Great news!” announced my Finance Director in our last board meeting, “last month we had a record level of invoiced sales”. “That’s fantastic” I said, “let’s pay a big bonus to everyone to celebrate.” “We can’t do that” she quickly replied, “we haven’t got enough cash in the bank. Most of those sales haven’t actually been paid for yet.”

Things to consider when looking at a business’s position….

Liquidity

They often say that “cash is king” in business, and I have certainly always been as interested in the cash position of my businesses, as in the profit that they are generating. Businesses often fail because of poor cashflow rather than poor sales, especially if a large proportion of sales are on credit. If you haven’t received enough cash from these credit customers you may not be able to pay your rent, your staff or your suppliers, meaning that the business will become insolvent. This cashflow position of a business is often described as it’s liquidity and is an important aspect of studying AAT.

Cashflow forecasting

Drawing up regular cashflow forecasts is a common approach to monitoring liquidity in a business. These differ from profit forecast because we are only interested in when the cash movement, in or out of a business happens and not when transactions, such as sales and purchases occur. Cashflow forecasts can often be more complex and time consuming and will involve considering both cash receipts (from customers, asset disposals, interest received to name a few) and cash payments (to suppliers, staff, the taxman etc.)

Let’s think about how we can deal with the cash receipts from sales made by the business:

Cash versus credit sales

Most businesses will see a split of sales made between those for cash (immediately settled on the date of the transaction) and those on credit terms (settled at a later date). Cash sales are paid for in the same month as the sale, with no delay to the cashflow.

So, for example if total sales in January are £100,000 with 10% for cash and the rest on credit, there would be £100,000 x 10% = £10,000 cash sales (which would be received in January) with the remaining 90% of sales (to make up to 100%), or £90,000 on credit.

Payment pattern of credit sales

Credit sales often then add an extra dimension of complexity in that these customers may pay at different times. Some may pay quite quickly, and some may take far longer which will delay the cash receipt.

From above, if 30% of credit sales are paid in the same month as the sale is made, 50% in the following month and the remaining 20% two months after the sale we would end up receiving:

  • £90,000 x 30% = £27,000 in January (along with the £10,000 of cash sales)
  • £90,000 x 50% = £45,000 in February
  • £90,000 x 20% = £18,000 in March

It’s worth checking that £27,000 + £45,000 + £18,000 = £90,000 total credit sales.

Dealing with discounts

As a way of encouraging credit customers to pay their balances quickly (which improves the liquidity of the business) they may be offered early settlement discounts. Although this should result in cash being received faster it means that we won’t receive the full value of the sales made.

Let’s say that credit customers settling in the month of the sale receive a 2% settlement discount, it would mean that we actually only receive 98% of the value of the sales being paid for. So in January we would actually only receive £27,000 x 98% = £26,460. Note that we don’t need to put the discount allowed of £540 (£27,000 x 2%) anywhere in our cashflow forecast. It’s just not included in the cash receipt.

Dealing with irrecoverable (or bad) debts

One of the potential drawbacks of making credit sales is that we may never be paid what the customers owe us. In a similar way to discounts we just need to reduce the value of cash receipts to reflect any irrecoverable debts.

So let’s say we had been told that 30% of credit sales pay in the same month as the sale, 50% in the month following the sale and only 15% two months after the sale. 30% + 50% + 15% only comes to 95% implying that 5% of sales are irrecoverable. This means that we would end up receiving only £90,000 x 15% = £13,500 in March.

Why don’t you have a go at this example task? When you have finished you can see me talk through my solution at…..

The following sales are anticipated by Rosalyn’s business over the next 5 months:

Month 1 £200,000
Month 2 £220,000
Month 3 £240,000
Month 4 £260,000
Month 5 £280,000

20% of sales are made on cash terms with the remaining sales being made on credit. Of these credit sales 20% of customers will pay in the same month as the sale, 50% will pay in the following month and 25% will pay two months after the sale was made. All other credit sales are considered to be irrecoverable. The credit customers who pay in the same month as the sale will receive a 5% early settlement discount.

Requirement:

Prepare a cash budget for receipts in months 3, 4 and 5.

View the debrief here.

If you found this article about Cashflow Forecasts useful, you may be interested in reading our ‘Don’t let ratios catch you out‘ article which dives into liquidity ratios, and how these focus on the ability of the business to generate cashflow.

Sign up to the Newsletter

Date

Title