Reyhan Huseynova

Business Management
Thu/May/6/2021
Activity: 31.2; 31.3; 31.4; 31.5; 31.6

ACTIVITY 31.2
April cash flow
[8 marks, 8 minutes]
Draw up a revised cash flow forecast for April assuming:
■ cash sales are forecast to be $1,000 higher
■ materials are forecast to be $500 higher
■ other costs are forecast to be $1,000 higher.

ANSWERS:

April Revised April

Cash inflows – all figures in 000£

Owner’s capital injection 0 0

Cash sales 6 7
Payments by debtors 3 3
Total cash in 9 10
Cash outflows
Lease 0 0
Rent 1 1
Materials 2 2.5
Labour 3 3
Other costs 1.5 2.5
Total cash out 7.5 9
Net cash flow 1.5 1
Opening balance -0.5 -0.5
Closing balance 1 0.5

ACTIVITY 31.3
Fashion-shop forecasts look good
‘I have stood outside some of these fashion shops for
hours counting the number of people coming out with
their carrier bags and I am convinced my sales forecasts
are OK,’ announced Sayuri to her business partner,
Korede. They were both putting the finishing touches
to their business plan for an exclusive ‘top brands only’
fashion store in the city. Sayuri’s primary research was
not the only evidence they had used in arriving at the
sales forecasts and the cash inflow forecasts. Some desk
research on the Internet had also revealed the rapid
growth of high-income consumer numbers spending
increasing amounts on expensive clothing.
Cash-outflow forecasts had been based on estimates
of electricity and telephone usage. Korede had found what he thought was a suitable shop,
so they knew how much the rent would be. They would pay themselves
a salary of $2,000 a month each initially. Other labour
costs were less certain. Should they employ full-time
 salaried staff or part-time hourly wage employees? The
cost of buying the clothes was also uncertain. There
would be no problem if they sold all the suits and dresses
that they bought in – but how likely was that? And what
would happen to cash-flow forecasts if stock was left
unsold and huge price reductions had to be advertised?
Whatever the uncertainties, both Sayuri and Korede
realised why they had to construct a cash-flow forecast
for their business plan. The almost completed forecast is
shown below:

[30 marks, 45 minutes]

1 Complete the cash-flow forecast by inserting values

for x, y and z. [3]

2 Analyse two problems of drawing up a cash-flow

forecast, which Sayuri and Korede may have
experienced. [6]

3 The first three months’ actual trading was poor and

cash sales were 20% below forecast. Draw up a new
cash-flow forecast for July assuming 20% lower
cash sales, 20% lower clothes purchases, an
opening cash balance of ($2,000) and all other
factors remaining unchanged. [7]

4 To what extent would drawing up a cash-flow

forecast increase the chances of this business
being successful? [14]

ANSWERS:

1) Net Monthly Cash Flow April: 34 – 35.5 = (1.5)

a. Total Cash Out: 0 + 2 + 4 + 3 + 1.5 + 0 = 10.5
b. Net Cash Flow July: 12 – 10.5 = 1.5

2) One problem that Sayuri and Korede might have experienced when drawing up
their cash flows forecast is that the values for their cash flow forecast were
undecided. They were undecided about whether they should employ full-time
salaried staff or part-time hourly wage employees. The cost of buying the clothes
was also uncertain and they were not sure if they were likely to sell all dresses and
 suits they brought in. They did not consider if stock was left unsold and whether
they had to make price reductions.

4) A cash flow forecast increases the chances of this business being successful since cash
flow forecasts have many limitations. A cash flow forecast allows mistakes to be made in
preparing the revenue and cost forecasts or they may be drawn up by inexperienced
entrepreneurs or staff. For example, Sayuri and Korede created their cash flow
statement based on observations of customers in other fashion shops in the city and
research from the internet. A cash flow forecast also does not consider unexpected cost
increases which can lead to major inaccuracies in forecasts. Sayuri and Korede drew up
their cash flow forecasts based on estimates of electricity and telephone usage. Korede
had also estimated the rent for what he thought was a suitable shop. These costs can
fluctuate based on how usage and since the figure for rent was estimated, the figure
could have been underestimated or overestimated either saving Sayuri and Korede
money or causing unforeseen costs. A cash flow forecast also allows incorrect
assumptions to be made in estimating the sales of the business, perhaps based on poor
market research and this will make the cash inflow forecasts inaccurate. Sayuri and
Korede conducted desk research into sales forecasts. This research could have been
poorly conducted and may have not been as detailed. They were both also uncertain
about the cost of buying clothes, the staffing they should hire and the situation they
would face if they did not sell all the suits and dresses they brought into the store. These
estimations, inaccuracies and unexpected cost increases can increase the chances of
this fashion shop’s business seeming more successful than it actually is.

ACTIVITY 31.4
[6 marks, 8 minutes]
Using your knowledge of finance from Chapter 28,
what sources of finance could a small business with
ambitious expansion plans use to prevent cash-flow
problems arising? [6]

ANSWERS:

Sources of finance include:

 Bank loans to finance capital equipment – bank loans have the advantage of
providing set repayments and this aids financial planning.
 Trade credit for purchase of stock – this is only a short-term source of finance
 Owner’s capital – this will help avoid over-dependence on debt financing.

ACTIVITY 31.5
Taxi firm’s cash flow
[8 marks, 8 minutes]
How would the following events be likely to affect the
cash flow of a taxi-operating company:
■ increase in oil prices
■ increased unemployment
■ lower train fares [8]

ANSWER
 Event Effect on cash flow
Increase in oil prices This will lead to an increase in the price of
fuel for the taxis.
This will lead to an increase in cash flows.
Increased unemployment This could lead to a reduction in demand for
taxi services as customers travel less. This in
turn reduces cash inflows. Less demand will
also reduce some of the cash outflows such
as fuel purchases.
Lower train fares This could lead to an increase in demand for
taxi as train passengers use taxis to complete
their journeys. There will, therefore, be an
increase in cash inflows from customers as
well as outflows associated with fuel
purchases.

ACTIVITY 31.6
Cash flow drying up for Indian
small firms Madhu Gupta has a problem. His company, Mojj
Engineering Systems, makes large-scale equipment
for food and chemical plants. His customers
keep ringing up and saying: ‘We don’t need the
equipment yet – hold it in stock,’ ‘Can we have an
extra discount?’ or even ‘We will only buy it if you
give us credit.’ ‘Three months back we had no idea things
could happen as quickly as this,’ said Madhu. ‘It
was too sudden to prepare for it.’ He was, of course,
complaining about the global recession and the
speed with which it has hit many businesses.
Madhu has already paid cash for all of his raw
materials. Completed machines are filling up the
yard in his factory. He will not get the money back
for materials bought, or for labour costs, until
he delivers these machines and is paid for them.
The finance the business was planning to use for
expansion to a new factory is now being used to pay
for the increase in working capital.
[24 marks, 30 minutes]

1 Explain the term ‘working capital’. [3]

2 Explain why Madhu is finding it so difficult to

control his working capital. [9]

3 Evaluate three ways in which Madhu could try to

reduce the finance tied up in working capital. [12]

ANSWERS:
1) Working capital may be defined as current assets less current liabilities. Working
capital is necessary to fund the day-to-day running of the business
 2) Mr Gupta is finding it difficult to control his working capital because of the
pressures being placed on cash inflows and outflows including:
• Customers are demanding credit terms for purchases, thus delaying cash inflows.

• Customers are expecting discounts, thus reducing cash inflows relative to cash outflows.

• The global recession has caused a drop in demand for machines for which his business
has already outlaid cash. Falling demand has resulted in a lack of cash inflows.
3) Method Commentary

Reduce stock This may be difficult to achieve in the short

term due to the recession having reduced
sales. Mr Gupta might be forced to reduce
prices considerably in order to shift
machines, but this could result in losses
being made on sales.

In the longer term, the firm should consider

just-in-time (JIT) stock control, but whether
this is feasible depends on the food and
chemical plants’ expectations of lead-time
for delivery of equipment.

Negotiate better credit terms with suppliers Mr Gupta could put pressure on his
suppliers to offer extended credit terms.
This will allow more time for the receipt of
income from customers. As suppliers also
face cash-flow problems, they will be
reluctant to extend credit terms; however,
due to falling sales they may be forced to
accept what Mr Gupta wants.

Controlling costs This could be achieved by reducing

administrative and production costs. It may
be necessary to reduce worker hours or
negotiate a pay reduction for employees.

It may be possible to replace labour with

machinery – this has an impact on short-
term capital availability, but will reduce the
working capital requirements over the
longer term. This may be an unsuitable
strategy as Mr Gupta faces a short-term
crisis and needs to reduce working capital
requirements immediately; therefore,
negotiating wage reductions with staff
would be preferable.