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a business as it struggles to get a foothold in the shi。。ing sands of trading；
cash flow is life or death。 The rules on what constitutes cash are very simple
– it has to be just that； or negotiable securities designated as being as good
as cash。 Cash flow is looked at in two distinct and important ways： as a
projection of future expected cash flows； and as an analysis of where cash
came from and went to in an accounting period and the resultant increase
or decrease in cash available。
Table 1。3 An example of a double…entry ledger
General Journal of Andrew’s Bookshop
Date Description of entry Debit Credit
10 July Rent expense ￡250
Cash ￡250
Accounting 25
Cash…flow forecasts
The future is impossible to predict with great accuracy but it is possible to
anticipate likely outes and be prepared to deal with events by building
in a margin of safety。 The starting point for making a projection is to make
some assumptions about what you want to achieve and test those for
reasonableness。
Take the situation of High Note； a business being established to sell sheet
music； small instruments and CDs to schools and colleges； which will expect
trade credit； and members of the public who will pay cash。 The owner plans
to invest ￡10；000 and to borrow ￡10；000 from a bank on a long…term basis。
The business will require ￡11；500 for fixtures and fi。。ings。 A further ￡1；000
will be needed for a puter； so。。ware and a printer。 That should leave
around ￡7；500 to meet immediate trading expenses such as buying in stock
and spending ￡1；500 on initial advertising。 Hopefully customers’ payments
will start to e in quickly to cover other expenses； such as some wages
for bookkeeping； administration and fulfilling orders。 Sales in the first six
months are expected to be ￡60；000 based on negotiations already in hand；
plus some cash sales that always seem to turn up。 The rule of thumb in the
industry seems to be that stock is marked up by 100 per cent； so ￡30；000 of
bought…in goods sell on for ￡60；000。
On the basis of the above assumptions it is possible to make the cashflow
forecast set out in Table 1。4。 It has been simplified and some elements
such as VAT and tax have been omi。。ed for ease of understanding。
The maths in the table is straightforward； the cash receipts from various
sources are totalled； as are the payments。 Taking one from the other leaves
a cash surplus or deficit for the month in question。 The bo。。om row shows
the cumulative position。 So； for example； while the business had ￡2；450
cash le。。 at the end of April； taking the cash deficit of ￡1；500 in May into
account； by the end of May only ￡950 （￡2；450 – ￡1；500） cash remains。
Overtrading
In the example above； the business looks like having insufficient cash；
based on the assumptions made。 An outsider； a banker perhaps； would
look at the figures in August and see that the faster sales grew the greater
the cash…flow deficit became。 We know； using our crystal ball； the position
will improve from September and that if we can only hang on in there for
a few more months we should eliminate our cash deficit and perhaps even
have a surplus。 Had we made the cash…flow projection at the outset and
raised more money； perhaps by way of an overdra。。； spent less on fixtures
and fi。。ings； or set a more modest sales goal； hence needing less stock and
advertising； we would have had a sound business。 The figures indicate a
business that is trading beyond its financial resources； a condition known
as overtrading； anathema to bankers the world over。
Table 1。4 High Note six…month cash…flow forecast
Month April May June July Aug Sept Total
Receipts
Sales 4；000 5；000 5；000 7；000 12；000 15；000
Owners’ cash 10；000
Bank loan 10；000
Total cash in 24；000 5；000 5；000 7；000 12；000 15；000 48；000
Payments
Purchases 5；500 2；950 4；220 7；416 9；332 9；690 39；108
Rates； electricity； heat；
telephone； internet etc
1；000 1；000 1；000 1；000 1；000 1；000
Wages 1；000 1；000 1；000 1；000 1；000 1；000
Advertising 1；550 1；550 1；550 1；550 1；550 1；550
Fixtures/fi。。ings 11；500
puter etc 1；000
Total cash out 21；550 6；500 7；770 10；966 12；882 13；240
Monthly cash
Surplus/deficit（–） 2；450 （1；500） （2；770） （3；966） （882） 1；760
Cumulative cash balance 2；450 950 （1；820） （5；786） （6；668） （4；908）
Accounting 27
Cash…flow spreadsheet
You can do a number of ‘what if’ projections to fine…tune cash…flow
projections using a spreadsheet： Business Link （businesslink。
gov。uk/Finance_files/Cash_Flow_Projection_Worksheet。xls） has a cashflow
spreadsheet that you can copy and paste into an Excel file on your
puter。
Statement of cash flows for the year
A cash…flow statement summarizes exactly where cash came from and how
it was spent during the year。 At first glance it seems to draw on a mixture
of transactions included in the profit and loss account and balance sheet for
the same period end； but this is not the whole story。 Because there is a time
lag on many cash transactions； for example tax and dividend payments；
the statement is a mixture of some previous year and some current year
transactions； the remaining current year transactions go into the following
year’s cash…flow statement； during which the cash actually changes hands。
Similarly； the realization and accrual conventions relating to sales and
purchases respectively result in cash transactions having a different timing
to when they were entered in the profit and loss account。
Example
A pany had sales of ￡5 million this year and ￡4 million last year and
these figures appeared in the profit and loss accounts of those years。 Debtors
at the end of this year were ￡1 million and at the end of the previous year
were ￡0。8 million。 The cash inflow arising from sales this year is ￡4。8 million
（￡0。8 million ＋ ￡5 million – ￡1 million） whereas the sales figure in the profit
and loss account is ￡5 million。
For these reasons it is not possible to look at just this year’s profit and loss
account and balance sheet to find all the cash flows； you need the previous
year’s accounts too。 The balance sheet will show the cash balance at the
period end but will not easily disclose all the ways in which it was achieved。
piling a cash…flow statement is quite a technical job and some training
plus inside information is needed to plete the task。 Nevertheless； the
bulk of the items can be identified from an examination of the other two
accounting statements for both the current and previous years。
From an MBA perspective it is understanding the requirement for a
cash…flow statement as well as the other two accounts that is important；
as well as being able to interpret the significance of the cash movements
themselves。
28 The Thirty…Day MBA
Straight Plc
The un…audited condensed cash…flow statement for Straight Plc； which was
established in 1993 as a supplier of container solutions for source…separated
waste； is shown in Table 1。5。 Initially one man and a desk； the pany
grew to bee the UK’s leading supplier of kerbside recycling boxes
as well as a key supplier of other types of waste and recycling container
solutions。 Turnover by 2008 was running at over ￡30 million a year； with
operating profit in excess of ￡1m。
The three columns represent the cash activities for two equivalent sixmonth
periods and for the whole of the preceding year。 The cash of ￡2；126
thousand generated to 31 December 2006 （bo。。om of the right…hand column）
is carried over to the start of the June 2007 six…month period （second figure
from bo。。om of le。。…hand column）。 By adding the net increase （or decrease）
in cash generated in this period we arrive at the closing cash position。
The cash…flow statement then gives us a plete picture of how cash
movements came about： from normal sales activities； the purchase or
disposal of assets； or from financing activities。 This is an expansion of the
sparse single figure in the pany’s closing balance sheet stating that cash
in current assets is ￡3；751 thousand。
THE PROFIT AND LOSS ACCOUNT
（INE STATEMENT）
If you look back to the financial situation in the High Note example you
will see a good example of the difference between cash and profit。 A。。er all；
the business has sold ￡60；000 worth of goods that it paid only ￡30；000 for；
so it has a substantial profit margin to play with。 While ￡39；108 has been
paid to suppliers； only ￡30；000 of goods at cost have been sold； meaning
that ￡9；108 worth of instruments； sheet music and CDs are still in stock。 A
similar situation exists with sales。 We have billed for ￡60；000 but been paid
for only ￡48；000； the balance is owed by debtors。 The bald figure at the end
of the cash…flow projection showing High Note to be in the red to the tune
of ￡4；908 seems to be missing some important facts。
The difference between profit and cash
Cash is immediate and takes account of nothing else。 Profit； however； is
a measurement of economic activity that considers other factors that can
be assigned a value or cost。 The accounting principle that governs profit
is known as the ‘matching principle’