This assignment involves writing notes to explain to Sharma and Ryan why businesses might face cash flow problems, the challenges they can lead to, and any potential risks that may be evident in SIGNature’s cash flow forecast. The definition and purpose of cash flow will also be discussed.
A cash flow is a measure of the money coming into and going out of a business regularly. A cash flow forecast predicts the expected inflows and outflows. It is crucial for every business to have a healthy cash flow for survival as it provides information about gross receipts and payments. Receipts include money received from the owner, investors, and customer sales, while payments consist of capital and revenue expenditures. The cash flow statement includes not only investing and financing activities but also interest and income tax payments, as well as significant non-cash investing and financing activities. There can be general cash flow issues.
Regardless of size or industry, any business can face cash flow issues based on incoming and outgoing money. Insufficient revenue can result in the inability to cover expenses, leading to a negative closing balance if outflows exceed the opening balance. Unfortunately, some businesses neglect these problems until they become overwhelming. Overspending when sales are low, lack of reserves for new businesses, insufficient profits, excessive upfront stock investments, generous customer credit terms, seasonal sales declines, and overtrading by rapidly opening multiple stores without sufficient funds can all contribute to cash flow challenges.
Other factors may also impact cash flow difficulties.
•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 can arise from these factors. One problem is the lack of cash flow, which can result in late payments for utility bills and additional interest charges. Moreover, insufficient funds may make it challenging for the business to purchase goods from suppliers and pay employees’ wages. This could potentially lead to a decrease in profit and a decline in customer service quality. Additionally, the business may struggle to afford necessary insurances aimed at protecting the business and its employees.
•Public liability insurance
•Professional indemnity
•Employers liability
•Business building insurance
•Business equipment
•Tool cover
•Stock insurance
•Other insurances
If the business is unable to afford these types of insurances, they may accumulate debt. Moreover, if the business possesses vehicles but lacks adequate funds to cover expenses like fuel, insurance, and road tax, they could be obliged to sell them. Furthermore, if the business has borrowed money from a bank and experiences a shortage of funds, they will struggle to repay the loan with interest, resulting in indebtedness. While obtaining additional stock ahead of time can be advantageous, it also carries risks if the products fail to sell well. In such circumstances, the business ends up utilizing capital income instead of revenue income, which adversely impacts their financial well-being. Insufficient pricing of products and services can lead to cash flow issues as expenditures on stock outweigh profits generated from sales. Additional cash flow challenges may arise from low employee productivity and performance levels that overlook problems capable of harming the long-term success of the business.
Potential risks exclusive to the cash flow forecast of SIGNature
The critical concern is the negative closing balance from January to April. Consequently, the opening balance from March to May will be substantially reduced, necessitating either bank loans or using personal funds from the owners. Such a situation poses risks to the business, including potential debt, insufficient cash flow to cover expenses and wages, resulting in a challenging period for the business during these four months.
SIGNature is using £20,000 in January for fixtures and fittings. However, if they need more fixtures and fittings later this year, their spending on the cash flow forecast will surpass the estimated amount.
Here is an example of a problem-
By increasing the amount of fixtures and fittings needed in June and July, the closing balance for these two months has become negative. Consequently, the opening balance for August has also turned negative (-£2,504), leaving the business without cash to buy stock, pay bills, wages, and other expenses in August. Despite this, the business still has to pay its revenue expenditure. This may require taking a loan from the bank, getting an overdraft, or using personal funds from the owners/investors. SIGNature will have to utilize its capital income to cover all the payments for July and August, potentially leading to less capital expenditure. The business must ensure it has enough cash from overdrafts or loans to manage the lack of funds in July and August. If they can sustain smooth operations during these months, they can recover from September as the opening balance will once again become positive, providing cash for the business.
Moreover, aside from the persistent cash flow issues, fresh challenges may emerge. For instance, acquiring another loan from the bank can result in a rise in loan repayment.
The business has had to borrow money from the bank in June and July due to excessive spending on fixtures and fittings. This borrowing is necessary to cover payments and wages, as there was a decrease in the closing balance for these months because of additional costs. As a result, there is a negative opening balance for July and August.
In January, the business borrowed £60,000 from the bank with monthly repayments of £1000 until the loan is fully paid off. However, an additional loan of £2000 is needed in July and £5000 in August to address the negative opening balance. These loans are separate from the January loan and cannot be repaid with £1000 per month.
The new loan of £7000 must be repaid by August and September according to the agreement with the bank. Since it was taken out with short notice, it needs to be repaid within a month. Therefore, the £2000 loan taken out in July will be repaid in August with added interest totaling £3525. Additionally, £6766 will need to be repaid in September.
Taking out a loan can help cover additional expenses but may also lead to further complications such as other forms of extra expenditure.
Another instance of a vital expenditure may involve acquiring new machinery or fixing current equipment in case it becomes damaged.
SIGNature has invested £85000 in initial machinery during their first year of operation. However, this investment does not guarantee that they will not require new equipment or that their current machines will remain in perfect condition. Therefore, it is crucial for them to consider acquiring additional machinery.
If SIGNature were to spend an extra £25000 on machinery in September, towards the end of their first year, they would find themselves with insufficient funds for bills and wages from October to December. The cash flow chart clearly demonstrates this, as the closing balance decreases from £9837 to -£15163 in September. As a result, there is a negative opening balance of -£15163 at the beginning of October.
This negative trend persists throughout the year since the opening balance can only be positive if each month’s closing balance is also positive. To avoid this issue, SIGNature could have divided the £85000 spent on machinery in January into 12 equal payments and purchased essential machinery in January.
To resolve this problem effectively, it would be advisable for SIGNature to reduce their expenditure on machinery in January and adjust future purchases based on their business’ progress. For instance, instead of spending £85000 solely in January, they could allocate £55000 in January, £5000 in February, and £10000 in April. This approach allows them to allocate a total of £70000 towards machinery rather than spending the entire amount upfront.Nevertheless, this choice will grant them an extra £25000 to be used in September, a critical period for acquiring machinery for their enhancements.
By spending £85000 on machinery in January, they can manage to maintain a positive closing balance from the first month to the end of the year.
