Analyse the cash flow and highlight any problems that are evident such as a shortage of cash and any other cash flow problems his business might experience. (M1) In P3, a cash flow forecast for John Adams was created. A cash flow forecast is a simple statement showing opening balance, cash in, cash out and closing balance. Cash flow forecast are usually compiled on a month by month basis, for up to twelve months ahead. The exact contents of an individual firm’s cash flow forecast will depend on the nature of its cash receipts and expenditure. However the basis structure for a cash flow forecast shows, the opening balance; which is the balance from the previous year, also known as the balance brought forward and the closing balance which how much money John Adams has at the end of the month. For example, the closing balance of £925.00 at the end of January becomes the opening balance at the start of February. John Adams has £625.00 pounds available at the start of the year; John then had sales of £18,900.00 in January, £17,010.00 in February and £15,750.00 in March.
The total cash available is opening balance plus total inflows. John had purchases of £13,500.00 in January, April and May, £12,150.00 in February and £11,250 in March while wages will be £3800 from January to April and then increases to £4175 in May and further increases to £5375 per month for the rest of year. Total outflows are all of John’s expenses added together. The closing balance is calculated by deducting the total outflows from the cash available. One month’s closing balance becomes the next opening balance becomes the next month’s opening balance. The timing of cash inflows and outflows are important. In John Adams cash flow it showed that at the end of 5 months John has a positive balance but for the rest of the months he a had a negative balance. This means that although her cash flow was healthy at the end of the 5 months, he had problems and would have an overdraft in his bank or he has been unable to pay one his expenses, which could stop him from operating successfully in the following months.
Failure to manage cash flows successfully will affect John Adams’ ability to trade effectively and generate profits. Even though John Adams has large positive cash balances at the end of every month such as £1447.50 at the end of April, are not necessarily profitable ones. Although sufficient cash needs to be kept back to pay for expenses, any surplus should be put to work, buying machinery and stock that can be turned into products and sold at a profit, rather than sitting in bank accounts earning no income. However the problems caused by a negative net cash balance, for example, Johan Adams had a negative cash balance of £6837.21 at the end of August tend to me more serious. Cash flow problems may mean that suppliers cannot be paid on the dates agreed, damaging relationships and leading to the withdrawal of credit or even refusal to supply at all. This, in turn, could mean that John Adams struggles to meet its order on time, creating customer dissatisfaction and a loss of sales.
If John Adams is unable to pay its debts, it may be taken to court by creditors, which could result in some cases, in it being forced to close down. Although it may not always be possible to avoid cash flow problems, being able to pinpoint what causes the problems is essential if an effective solution is to be found. Some cash flow problems that John Adams business may experience are: If he invested too much in fixed assets :- even though capital investment is usually required when a business is first setting up or choose to expand, acquiring premises, machinery and equipment ca involve a significant amount of finance, leaving insufficient finance to cover the expenses incurred in running the business on a day to day basis. He also probably gave customers too much credit sales. Offering trade credit can help win sakes and retain customers. However credit sales do not necessarily create cash problems, as long as John Adams plans for the delay in payment for sales. The longer the credit period offered to customers, the longer it will before cash flows into the business.
The wider the gap between having to pay expenses involved in meeting orders and receiving money from sales, the greater the risk of cash flow turning negative. John Adams selling on credit may also struggle if customers fail to pay by the date agreed, or go out of business without paying all. Overtrading is also another cash flow problem he may face. Rapid expansion without securing sufficient finance can also lead to cash flow problems. The costs of materials and labour will be increasing and will usually need to be covered well in advance of payment being received from customers, especially if they have been granted generous credit terms. The wider the gap between cash outflows and cash inflows the greater the risk of experiencing cash flow problems. John Adams may also see an unexpected fall in sales.
The actual level of sales can differ dramatically from those expected for a number of reasons. Initial estimates may have been based on inaccurate market research, over exaggerating the strength of demand. However even accurately researched sales figures can fall to materialise due to an unexpected increase in competition or a sudden and sharp downturn in the economy. John will already purchase stock, machinery and hired labour in anticipation of much higher sales. This will still need to be paid for, even if they are unlikely to generate the cash inflow required to prevent a cash flow crisis.