Cash Flow Forecasts (DP IB Business Management)
Revision Note
Cash Flow Forecasts
A cash flow forecast is a prediction of the anticipated cash inflows and cash outflows, typically for a six to twelve month period
A detailed business plan should include a cash flow forecast that allows the business owners to identify its financial needs
Key terminology and an example
The net cash flow is calculated by subtracting total outflows from total inflows
The opening balance is the previous month’s closing balance carried forward
The closing balance is calculated by adding the net cash flow to the opening balance
An Example of a Start-up Six-month Cash Flow Forecast (£s)
| Jan | Feb | Mar | Apr | May | Jun |
|---|---|---|---|---|---|---|
Inflows | ||||||
Cash received from sales | 2,600 | 2,800 | 3,100 | 4,600 | 4,800 | 5,200 |
Capital introduced | 6,000 | 0 | 0 | 0 | 0 | 0 |
Total inflows | 8,600 | 2,800 | 3,100 | 4,600 | 4,800 | 5,200 |
Outflows | ||||||
Inventory | 1,500 | 850 | 950 | 1,300 | 1,350 | 1,400 |
Wages | 2,200 | 2,200 | 2,200 | 2,200 | 2,200 | 2,200 |
Utilities | 840 | 840 | 840 | 882 | 882 | 882 |
Loan repayments | 0 | 284 | 284 | 284 | 284 | 284 |
Miscellaneous | 230 | 240 | 250 | 410 | 260 | 260 |
Total outflows | 4,770 | 4,414 | 4,524 | 5,076 | 4,976 | 5,026 |
Net cash flow | 3,830 | (1,614) | (1,424) | (476) | (176) | 174 |
Opening balance | 500 | 4,330 | 2,716 | 1,292 | 816 | 640 |
Closing balance | 4,330 | 2,716 | 1,292 | 816 | 640 | 814 |
Analysis of the cash flow forecast example
Executive Summary
Overall, this cash flow forecast supports an application for the business to borrow £6,000 in January to cover the initial low inflows, significant outflows and negative net cash flow
As sales increase from June, inflows are greater than outflows and the business has a positive cash flow
Should a loan be approved, the business will require any short-term sources of finance, such as overdraft facilities
January
The cash flow forecast assumes that the bank approves a £6,000 loan in January (capital introduced)
The opening balance of £500 has been introduced by the owner
The business is expected to achieve sales of £2,600
Total inflows are therefore expected to be £8,600 (£2,600 + £6,000)
Total outflows are expected to be £4,770
The Net Cash Flow is expected to be £3,830 (£8,600 - £4,770)
January’s closing balance is expected to be £4,330 (£3,830 + £500)
February
The closing balance from January becomes the opening balance for February
Sales of £2,800 as expected to be the business total inflows
Total outflows are expected to be £4,414
The Net Cash Flow is expected to be -£1,614 (£2,800 - £4,414)
The closing balance is expected to be £2,716 (-£1,614 + £4,430)
March
The closing balance from February becomes the opening balance for March
The business expects to achieve sales of £3,100 as its total inflows
Total outflows are expected to be £4,524
The Net Cash Flow is expected to be -£1,424 (£3,100 - £4,524)
The closing balance is expected to be £1,292 (-£1,424 + £2,716)
April
The closing balance from March becomes the opening balance for April
Sales of £4,600 are expected as the businesses total inflows
Total outflows are expected to be £5,076
The Net Cash Flow is expected to be -£476 (£4,600 - £5,076)
The closing balance is expected to be £816 (-£476 + £1,292)
May
The closing balance from April becomes the opening balance for May
The business expects to achieve sales of £4,800 as its total inflows
Total outflows are expected to be £4,976
The Net Cash Flow is expected to be -£176 (£4,800- £4,976)
The closing balance is expected to be £640 (-£176 + £816)
June
The closing balance from May becomes the opening balance for June
Sales of £5,200 are the business total inflows
Total outflows are expected to be £5,026
The Net Cash Flow is expected to be £174 (£5,200-£5,026)
The closing balance is expected to be £814 (£174 + £640)
Worked Example
Here is a simple three-month cash flow forecast for a small seaside café
| March | April | May |
|---|---|---|---|
Inflows | |||
Sales | 46,000 | 54,000 | 61,000 |
Outflows | |||
Inventory | 13,000 | 13,000 | 13,000 |
Wages | 28,000 | 28,000 | 28,000 |
Miscellaneous | 3,500 | 4,000 | 4,000 |
Total Outflows | 44,500 | 45,000 | 45,000 |
Net cash flow | 1,500 | 9,000 | 16,000 |
Opening balance | 4,000 | 5,500 | 14,500 |
Closing balance | 5,500 | 14,500 | 30,500 |
The café owner thinks that good weather will increase the volume of customers and decides to appoint another full-time assistant in March. As a result, wages increase to an expected £31,000 per month
Calculate the closing balances in the cash flow forecast resulting from the changes above. [4]
| March | April | May |
|---|---|---|---|
Inflows | |||
Sales | 46,000 | 54,000 | 61,000 |
Outflows | |||
Inventory | 13,000 | 13,000 | 13,000 |
Wages | 31,000 | 31,000 | 31,000 |
Miscellaneous | 3,500 | 4,000 | 4,000 |
Total Outflows | 47,500 | 48.000 | 48,000 |
Net cash flow | (1,500) | 6,000 | 13,000 |
Opening balance | 4,000 | 2,500 | 8,500 |
Closing balance | 2,500 | 8,500 | 21,500 |
Answer:
Step 1: Insert the value of the new wages into the relevant space for each month
Step 2: Calculate the new total outflows for each month and insert them into the relevant space for each month
March: £13,000 + £31,000 + £3,500 = 47,500
April: £13,000 + £31,000 + £4,000 = 48,000 [1 mark]
May: £13,000 + £31,000 + £4,000 = 48,000
Step 3: Calculate the new net cash flow for each month and insert it into the relevant space for each month
March: £46,000 - £47,500 = -£1,500
April: £54,000 - £48,000 = £6,000 [1 mark]
May: £61,000 - £48,000 = £13,000
Step 4: Calculate and insert the new closing balance for March and carry it forward as the opening balance for April
£4,000 + - £1,500 = £2,500 [1 mark]
Step 5: Calculate and insert the new closing balance for April and carry it forward as the opening balance for May
£2,500 + £6,000 = £8,500 [1 mark]
Step 6: Calculate and insert the new closing balance for May
£8,500 + £13,000 = £21,500 [4 marks for the correct answer]
Note that this one change in the anticipated cost of wages impacts four other variables 1.Total outflows 2. Net cash flow 3. Opening balance (except March) 4. Closing balance
Exam Tip
When calculating opening and closing balances, work through each month in turn.
Always double-check your calculations in cash flow forecasts as one mistake will have a knock-on effect elsewhere and, in some cases, lead you to make inaccurate judgements.
Evaluating Cash Flow Forecasts
Cash flow forecasts provide insights into the expected inflows and outflows of cash over a specific period
By analysing these forecasts over time, businesses can better plan and allocate their financial resources
It is also important to recognise that cash flow forecasts have limitations
The Uses & Limitations of Cash Flow Forecasts
Advantages | Disadvantages |
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Exam Tip
Look for clues in the case study about the reliability of the forecast and draw some judgments on the reliability of the forecast presented.
New entrepreneurs find it especially difficult to create accurate forecasts as they have little experience to draw on. They often make use of free advice and guidance (e.g. from banks) or conduct significant research to support their forecasts. In these cases, the cash flow forecast is likely to be an excellent tool for planning. Where the cash flow forecast is constructed without such care it can hinder business progress and can undermine the business plan as a whole.
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