Cash Flow Planning Flashcards

Question 1

What does the term cash flow mean in financial planning?

Accepted Answer

Cash flow is the movement of money into and out of a business or household over a period. Cash inflows are receipts such as customer payments, while cash outflows are payments such as wages, rent, and loan interest. The net difference between them shows whether cash balances grow or shrink during that period.

Question 2

How does cash flow differ from profit in an accounting sense?

Accepted Answer

Profit is revenue minus expenses under accrual accounting, so it records income when earned and costs when incurred, regardless of when money changes hands. Cash flow tracks only actual receipts and payments. A business can report a profit while running short of cash, because credit sales and depreciation affect the two measures differently.

Question 3

Why is timing so central to cash flow planning?

Accepted Answer

Timing matters because a business can be profitable on paper yet unable to pay a bill due this week. Planning compares when inflows arrive with when outflows are due, revealing gaps where the balance may fall below zero even when yearly totals look healthy.

Question 4

What is a cash balance, and why does it need to stay above zero?

Accepted Answer

A cash balance is the amount of money held in accounts or on hand at a given moment. It must stay above zero because a negative balance means obligations cannot be paid as they fall due, which can trigger overdraft fees, late penalties, or default on loans.

Question 5

How is net cash flow calculated for a single period?

Accepted Answer

Net cash flow is total cash inflows minus total cash outflows for a single period. A positive result means more cash came in than went out, increasing the balance, while a negative result means the balance fell. For example, 12,000 in receipts and 9,500 in payments give a net cash flow of 2,500.

Question 6

Why do small businesses and households both need cash flow planning?

Accepted Answer

Both need it because income and expenses rarely line up across the month. Wages may be paid before customers pay invoices, and a household may face a car repair before the next paycheck. Early warning lets the owner or family borrow, delay spending, or adjust collections before a shortfall becomes a crisis.

Question 7

What is a cash shortfall, and how does it differ from a loss?

Accepted Answer

A cash shortfall occurs when outgoing payments exceed the cash available to cover them, even if total income is sufficient over time. A loss is an accounting result in which expenses exceed revenue over a period. A business can have a shortfall without a loss and the reverse is also possible.

Question 8

Why do planners prefer a monthly or weekly time horizon for cash forecasts?

Accepted Answer

Shorter horizons such as weekly or monthly periods reveal timing gaps that annual totals hide. Cash moves on specific dates, so a forecast must show each week's receipts and payments to catch a shortfall before it occurs. Near term forecasts guide daily decisions about paying bills and drawing on credit.

Question 9

What are the three main categories of cash flow in a standard cash flow statement?

Accepted Answer

The three main categories are operating, investing, and financing activities. Operating activities cover cash from core business operations such as sales and supplier payments. Investing activities cover buying and selling long term assets and investments. Financing activities cover borrowing, repaying debt, and transactions with owners such as dividends or capital contributions.

Question 10

What typically counts as an investing cash flow?

Accepted Answer

Investing cash flows usually involve purchasing or selling long term assets such as equipment, vehicles, buildings, or securities held for investment. Buying a delivery van creates an outflow, while selling old machinery creates an inflow. Because these purchases are often large and infrequent, they can cause a sharp swing in net cash flow.

Question 11

Why can a company report strong operating cash flow while its total cash falls?

Accepted Answer

Total cash can fall even when operations generate cash, because large investing outflows, such as buying equipment, or financing outflows, such as repaying loans, may exceed the operating surplus. Reading the three sections together shows where cash was actually used. Analysts therefore look at each category, not only the bottom line.

Question 12

Why is positive operating cash flow generally viewed as a sign of a healthy core business?

Accepted Answer

Positive operating cash flow means routine activities bring in more cash than they consume, so the core business can fund itself without relying on new debt or asset sales. It indicates that reported earnings are supported by actual collections. Persistent negative operating cash flow signals that the core model needs outside funding.

Question 13

What is free cash flow, and how is it commonly estimated?

Accepted Answer

Free cash flow is the cash left after a business pays for the capital spending needed to maintain or expand its assets. A common estimate subtracts capital expenditures from operating cash flow. The result shows how much cash is available for debt repayment, dividends, or new opportunities without disturbing existing operations.

Question 14

How can a reader tell whether a company depends on borrowing to stay afloat?

Accepted Answer

A reader can tell by comparing net financing cash flow with net operating cash flow over several periods. If financing inflows consistently cover operating shortfalls, the business relies on new debt or equity to meet its obligations. Repeated borrowing to fund routine payments is a warning sign.

Question 15

Is a customer's payment for goods counted as an operating or investing cash flow?

Accepted Answer

A customer payment for goods or services is an operating cash inflow because it comes from the core activity the business performs. Investing applies to asset purchases and sales, not to ordinary sales. Keeping this distinction keeps each section's totals accurate.

Question 16

What does a negative investing cash flow usually indicate?

Accepted Answer

A negative investing cash flow usually means the business spent cash on long term assets or investments during the period. For a growing company this is often healthy, since purchases of equipment or facilities support future operations. A negative figure should be read alongside the business plan rather than judged alone.

Question 17

What are the direct and indirect methods of preparing the operating section?

Accepted Answer

The direct method lists major categories of cash received from customers and cash paid to suppliers and employees. The indirect method starts with net income and adjusts it for noncash items and changes in working capital accounts. Both methods arrive at the same net cash from operating activities, but they present the calculation differently.

Question 18

Which noncash expense is most often added back when using the indirect method?

Accepted Answer

Depreciation is the most common noncash expense added back under the indirect method. It reduces net income on the income statement but does not involve any cash payment in the current period, so adding it back offsets its effect. Amortization of intangible assets is treated similarly.

Question 19

How does an increase in accounts receivable affect operating cash flow under the indirect method?

Accepted Answer

An increase in accounts receivable reduces operating cash flow, so it is subtracted from net income. Sales were recorded as revenue, but customers have not yet paid, so the cash has not arrived. Conversely, a decrease in receivables is added, because collections exceed new credit sales during the period.

Question 20

Why does an increase in accounts payable increase operating cash flow under the indirect method?

Accepted Answer

An increase in accounts payable increases operating cash flow because expenses were recorded but the cash has not yet left the business, so the adjustment is added to net income. A decrease in payables works in reverse, since paying old bills reduces cash without changing current income.

Question 21

What is the main reason the direct method is considered easier to read?

Accepted Answer

The direct method shows actual cash receipts and payments by category, so readers see the source and use of cash without reconstructing it from accrual figures. It answers directly how much came from customers and how much went to suppliers and staff.

Question 22

What is a reconciliation in the context of a cash flow statement?

Accepted Answer

A reconciliation in this context is a schedule that starts with net income and explains each adjustment needed to reach net cash from operating activities. It is the core of the indirect method, showing noncash charges, gains, and working capital changes one by one.

Question 23

How are gains on the sale of equipment handled under the indirect method?

Accepted Answer

A gain on sale is subtracted from net income under the indirect method, because the full sale proceeds are reported in investing activities. Leaving the gain in operating cash flow would count the same money twice. A loss on sale is added back, since the cash appears only in the investing section.

Question 24

Why must a cash flow statement reconcile to the change in the cash balance on the balance sheet?

Accepted Answer

It must reconcile because the three sections together account for every movement in cash, so their sum must equal the change in the balance. This check confirms that every movement has been classified and that no cash has gone missing from the analysis. A mismatch signals a recording or classification error.

Question 25

What is a cash flow forecast, and what does it estimate?

Accepted Answer

A cash flow forecast is a projection of expected cash receipts and payments over future periods, usually weeks or months. It estimates when money will arrive and leave, so the planner can spot periods when the balance may fall below an acceptable minimum. Forecasts are revised regularly as actual results replace estimates.

Question 26

What are the main sources of cash inflow to include in a forecast?

Accepted Answer

Typical inflows include customer collections, cash sales, loan proceeds, owner contributions, interest income, and proceeds from selling assets. Collections deserve the most care, because they depend on when customers actually pay rather than when invoices are issued. Planners often apply a realistic delay pattern to credit sales instead of assuming immediate receipt.

Question 27

Why should forecasts include a contingency or buffer?

Accepted Answer

Forecasts rely on assumptions about sales, costs, and timing, and actual results rarely match them exactly. A contingency adds a margin for errors such as late customer payments, unexpected repairs, or a slower sales month. Holding a buffer protects the business from having to make emergency borrowing decisions under pressure.

Question 28

What is a rolling forecast, and how does it differ from a fixed annual budget?

Accepted Answer

A rolling forecast extends a set number of periods ahead and is updated each time a period closes. A fixed annual budget covers one set year and is typically left unchanged until the next cycle. Rolling forecasts respond more quickly to changing conditions, while annual budgets provide a stable benchmark for measuring performance.

Question 29

How do you build a cash budget from a sales forecast?

Accepted Answer

Start with projected sales, convert them to expected collections using the typical payment delay, and add other inflows. Then list all planned payments, such as purchases, wages, rent, and loan payments, by their due dates. The net of inflows minus outflows, added to the opening balance, gives the closing balance for each period.

Question 30

What is the purpose of a sensitivity analysis in cash planning?

Accepted Answer

A sensitivity analysis tests how the cash forecast changes when key assumptions change, such as a slower collection period, lower sales, or higher supplier costs. It shows which variables have the greatest effect on the closing balance. Planners use these results to decide how much buffer to hold and which risks to monitor closely.

Question 31

Why is a timing difference between sales and collections a planning concern even when sales are rising?

Accepted Answer

Rising sales often increase receivables, meaning the business must finance more goods and labor before customers pay. Growth can therefore consume cash even while profits improve. Without a forecast, a company may reach its credit limit during a period of apparent success, forcing it to slow orders or delay supplier payments.

Question 32

What is a variance analysis in cash budgeting?

Accepted Answer

Variance analysis compares actual cash receipts and payments with the budgeted amounts for each period and explains the differences. A favorable variance means inflows exceeded or outflows fell short of the plan, while an unfavorable one means the reverse. Reviewing variances regularly shows whether the forecast assumptions were realistic and guides future revisions.

Question 33

What is working capital, and how is it calculated?

Accepted Answer

Working capital is current assets minus current liabilities, measuring the short term resources available to meet obligations due within a year. Current assets include cash, receivables, and inventory, while current liabilities include payables, short term debt, and accrued expenses. A positive result suggests the business can cover near term bills.

Question 34

How does a shortened collection period improve cash flow?

Accepted Answer

Shortening the collection period means customers pay sooner, so cash from existing sales arrives earlier without any increase in sales. Tighter credit terms, prompt invoicing, and reminders for overdue accounts are common ways to achieve this. The gain is real but bounded, since overly strict terms can drive away customers and reduce future revenue.

Question 35

How can delaying payments to suppliers help a business manage a shortfall, and what are the risks?

Accepted Answer

Stretching payables keeps cash in the business for a longer period, which can bridge a temporary gap between receipts and outflows. The risks include late payment fees, lost early payment discounts, strained supplier relationships, and possible loss of trade credit. Suppliers may respond by tightening terms.

Question 36

What is a bank overdraft facility and when is it appropriate?

Accepted Answer

A bank overdraft facility lets an account balance fall below zero up to a set limit. It is suited to short term gaps between receipts and payments, since interest and fees are typically charged on the amount used. Using an overdraft to cover ongoing losses is costly and signals a deeper problem.

Question 37

What is a line of credit, and how does it differ from a term loan?

Accepted Answer

A line of credit is a revolving borrowing limit that can be drawn, repaid, and drawn again. A term loan provides a fixed sum repaid on a set schedule, and it cannot be redrawn. Revolving credit suits fluctuating working capital needs, while term loans usually fund specific purchases with predictable repayment.

Question 38

What steps should a business take first when a cash shortfall is forecast?

Accepted Answer

First, confirm the size and timing of the gap by updating the forecast with the most current information. Next, look for quick actions such as accelerating collections, deferring discretionary spending, or negotiating payment schedules. If a gap remains, arrange short term financing early while the business still has good credit standing. Waiting until cash runs out narrows every choice.

Question 39

Why is a cash shortfall often more dangerous for a growing business than for a stable one?

Accepted Answer

Growing businesses commit cash to inventory, staff, and equipment before the resulting sales are collected, so their needs rise faster than their cash generation. A shortfall can therefore appear even when the business is profitable and expanding. If lenders or suppliers lose confidence at that point, the growth itself may become unsustainable.

Question 40

What is the cash conversion cycle, and why does it matter?

Accepted Answer

The cash conversion cycle measures the number of days between paying for inventory and collecting cash from the resulting sales. It equals days inventory outstanding plus days sales outstanding minus days payables outstanding. A shorter cycle means cash is tied up for less time, so a business needs less outside funding to operate.

Cash Flow Planning Flashcards

1Cash Flow Fundamentals

2Operating, Investing and Financing Activities

3Preparing the Cash Flow Statement

4Forecasting and Cash Budgeting

5Shortfalls and Working Capital

Learning Resources