Business Revision

Business revision
Cash flow forecast
Three main elements:

- Cash inflows from cash sales, debtors’ payments, interest received, bank loans…
- Cash outflows occur when the organisation pays creditors, makes cash purchases,
buys assets, and pays taxes, wages and rent and any other cash expenses.
- Net cash flow is the difference between cash inflows and outflows. Ideally, this
should be positive, although organisations can survive negative cash flows if they
find alternative cash sources, e.g., an overdraft.
Key term: ào^mpùl:=^p

A cash flow forecast is an estimate of the timing and amounts of cash inflows and outflows
into an organization over a specific period, usually one year.
Too little cash results in:

- Non-payment of suppliers
- Discounts lost for late payment
- Wages and salaries delayed, causing poor motivation, high labour turnover and
absenteeism
- New capital assets being unaffordable
- Unpaid taxes.
Cash flow forecasts:

A cash flow forecast is an attempt by management to prevent future liquidity problems.
Each month a firm estimates the amount of cash entering and leaving the business and
whether this will result in a cash deficit or surplus. If an overdraft is predicted, the managers
will have to consider solutions. These could include:
- Arranging an overdraft.
- Arranging a longer-term loan.
- Rescheduling payments or considering alternative purchase solutions.
- Selling assets or postponing purchase.
- Finding cheaper suppliers.
- Reducing credit terms for customers or lengthening credit terms with suppliers.
Important terms in a cash flow forecast:

- Opening cash balance: for each month it is the closing cash balance of the previous
month.
- Total cash inflows: the sum of all the cash onflows for a particular month.
- Total cash outflows: the sum of all the cash outflows for a particular month.
- Net cash flow: the difference between the total cash inflows and the total cash
outflows.
- Closing cash balance is calculated by adding the net cash flow of a particular month
to its opening balance.
Profitability and efficiency ratios
Profitability ratios:
Profitability measures performance and effectiveness, comparing profit to something else
and telling the stakeholders if profit is sufficient or adequate.
Profit margins:
We compare profits with sales revenue in two main ways, using gross profit margin and net
profit margin. A comparison of the two profit margins raises questions about management
efficiency. If, for example, the gross profit margin was improving at the same time as the net
profit margin declined, this points to poor control of expenses.
Gross profit margin:

This ratio compares a firm’s gross profit to its sales revenue; in other words, the percentage
of the selling price that is gross profit and available to pay the firm’s overheads. A
benchmark for many industries is 20%. Gross profit margin is the firm’s mark-up on the
items it buys in.
gross profit
Gross profit margin= x 100
sales revenue
Net profit margin:

This ratio calculates the percentage of a product’s selling price that is net profit, expressed
as a percentage. It is a better measure of a firm’s performance than gross profit margin as it
includes all operating expenses and measures how successfully the firm controls expenses.
A higher percentage is preferable and may be achieved by raising sales revenue while
maintaining or reducing expenses.
net profit
Net profit margin= x 100
sales revenue
Efficiency ratios
Efficiency ratios tell shareholder how effectively the firm is using their money. Firms try to
get as much turnover from their assets as possible.
Return on capital employed (ROCE)

Also known as the primary efficiency ratio, this is regarded as the most important ratio.
net profit before interest ∧tax

Return on capital employed= x 100
total capital empl oyed
This ratio uses net profit before interest and tax because this value is controllable by the
management, unlike net profit after interest and tax.
Total capital employed:
shareholder s ' funds+longterm liabilities
THE HIGHER THE RATIO THE BETTER, as ROCE measures profitability. If the ROCE is less than
interest rates, shareholders are better leaving their money in the bank.
In manufacturing, a benchmark ROCE is in excess of 10% and, in retail, lower figures would
be experienced, ranging between 5% and 15%. However, it will depend on several factors,
such as the:
- Industry,
- State of the economy,
- Interest rate,
- Size and age of the firm,
- Requirements of the firm.
If the ROCE is falling, the firm may:

- Increase profit generated using the same level of capital by increasing efficiency,
- Maintain the profits generated using less capital.
Liquidity Ratios
Liquidity is the ability of a firm to meet its liabilities and pay its bills. A firm is liquid if it can
pay its bills, illiquid if it cannot. Liquidity ratios measure the short-term financial health of
the business.
Working capital is the lifeblood of an organisation:

- Too little and the firm may not be able to pay its debts, which may end in closure.
- Too much shows the business is not using financial resources efficiently.
Two liquidity ratios: The current ratio and the acid-test ratio.
Current ratio
The current ratio reflects the firm’s working capital position and its ability to pay its short-
term creditors from the realisation of its current assets without selling any fixed assets. It is
simply the ratio of all current assets to current liabilities:
Current ratio =
current assets(stock+ debtors+cash)
x 100
current liabilities (creditors+ overdraft+ shortterm loans)

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Business revision

Cash flow forecast

Three main elements:

Key term: ào^mpùl:=^p

Too little cash results in:

Cash flow forecasts:

Important terms in a cash flow forecast:

Gross profit margin:

Net profit margin:

Return on capital employed (ROCE)

net profit before interest ∧tax

If the ROCE is falling, the firm may:

Working capital is the lifeblood of an organisation:

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