Company Accounts

This section is all about Cash Flow Management. As always Iíll start with a definition.

Cash Flow- Cash Flow is the money flowing into and out of a business.

Net Cash Flow- Net Cash Flow is the difference between the money which comes in and the money which goes out.


Cash flow management is about the short term control of cash in order to ensure all short term debts are managed. Cash flow is incredibly important because if it is not managed properly firms which are essentially profitable can still fail if the firm is unable to pay a creditor who requires payment quickly and in cash.

In order to manage Cash Flow effectively, firms can take a number of steps. One of these steps is to invest time into drawing up Cash flow forecasts. This enables an organisation to identify potential problems and take appropriate financial action. For example: arranging a bank overdraft.


Why bother with Cash flow forecasting?

Cash flow forecasting helps businessís to: 

  • Forecast periods in a businessís or productís lifecycle where cash outflow may exceed cash coming in.
  • Plan how to finance major areas of expenditure.
  • Ensure that liquid assets are available to meet debt payments.
  • Highlight periods where cash is in excess and can therefore be profitably invested in some other aspect of the business.
  • Justify to lenders/creditors that any money owed can and will be paid.


How can Cash flow be improved? 

There are many ways of managing cash flow in order to improve a firmís financial position.

Some are short term solutions whereas others may be more suitable as long term arrangements.


Stock Management: Managing stock is crucial in determining the strength of a companyís cash flow position especially regarding businesses that rely heavily on the rotation of stock from warehouse to shop floor i.e. supermarkets. If a company were to have high stock levels they would benefit from the advantages of bulk buying and other economies of scale. However they would suffer with the problem of storing all the stock and run the risk of losing money on stock which spoils easily or have low sell by dates.

Sale and leaseback: This involves the sale of assets in order to boost cash flow in the short term. Once assets have been sold i.e. property they may need to be leased back in order to continue the business function. This may be necessary for companies in need of a lump sum.

Debt Collecting: Although this may seem obvious, the collection of debts from firmís owing you money is extremely important in maintaining a strong cash flow position. If a firm decides to delay payment of their debt then an option is to bring in a factoring company. Factoring companies operate by giving the company owed money an immediate lump sum of cash whilst collecting the debts owed to that company for themselves, whilst obviously charging for the service. Debt collection becomes even more important when looking at the way in which most businesses operate on a B2B (Business to Business) basis. What this means is that the likelihood of debts being withheld increases due to the fact that each company involved has to look out for their own cash flow position and will delay payment often in order to improve their own cash flow.


Sources of finance

As well as Cash Flow and Profit there is also another term referring to another use of cash within a business and this is finance. Finance is a term used to describe money which is solely used to cover company expenditures, of which there are two different types:

Revenue Expenditure: This is expenditure which takes place on a day to day basis and covers costs such as wages and raw materials. This type of expenditure generally provides a quick return due to the productive nature of a workforce and the fact that raw materials are going towards the production of products available to sell. Companies therefore need only rely on short term sources of finance for this type of expenditure.

Capital Expenditure: This expenditure revolves around the purchase of fixed assets which can be used numerously for the benefit of the company. For example: a new machine in a factory. It is probable that these items will be expensive and take a long time to cover the cost of their purchase so as a result long term sources of finance are required to cover this sort of expenditure.

In terms of different sources of finance there are many but they can be categorised into these two main categories:

External Sources: This refers to sources of finance which are unrelated to the cash generated by the internal sales from a particular company and include things such as Venture Capital, Bank loans, Bank Overdrafts, Debentures and shares, all of which you should have learnt in your lessons.

Internal Sources: As the name suggests these sources of finance are produced internally and are directly related to the cash generated by a business in terms of how often they can be relied upon. They include things such as retained profit, working capital and sale of assets.


External and internal sources of finance can be further sub-categorised into long term and short term finance solutions but this is not particularly important for the exam.