How to Do a Cash Flow Analysis for Small Business (Example)
Cash Flow Analysis
The cash flow forecast for the year 2007 is showing a promising investment. The cash flow predicts that the crisis period for “The Lithuanian Sunset” is going to be the first 5 months of operation due to extortionate start-up costs and outflows being greater than inflows. This in effect reduces the feasibility of “The Lithuanian Sunset” as it will experience a shortage of working capital and I and my partner will have to have a certain reserve of around £5,000 in order to avoid borrowing as it would put us in a red and increase the gearing of the business, which would result in opportunity costs of additional of our capital being spent on repaying loans, instead of being invested in running the business. Moreover, a possible way to increase the feasibility of the business would be to reduce the negative closing balances during the first 5 months, which could be achieved by introducing a Just in time system in order to reduce the cost of buying a great amount of stock. Yet, the cash flow forecast is only an estimate and it is thus unable to show accurate levels of demand, so it would thus be safer to hold buffer stock in order to satisfy the consumers. A better approach would be to negotiate trade credit with “Lituanica”, but even such an approach could be hindered since “The Lithuanian Sunset” does not have a reputation for financial security and the debt may not be repaid and thus result in a bad debt for “Lituanica”. Nevertheless, the negative figures in closing balances are turning into positives almost twofold (after second month). June is supposed to be the break-even point of the business due to the estimated increase in demand, however, elasticity of advertising would help to decide whether the advertising costs would be reflected in demand for products, as the cash flow forecast thus suggests. “The Lithuanian Sunset” will only advertise in the media for 3 months, as it is assumed that after this period “The Lithuanian Sunset” will have established a customer base, partly due to word-of-mouth. After June the feasibility of a Lithuanian shop could be increased as “The Lithuanian Sunset” is predicted to be making a steady profit, which is partly due to increased capacity utilization as “The Lithuanian Sunset” would have managed to establish its reputation and brand name. This in effect would result in an increased stock turnover coming from increased demand, which would shorten the liquidity cycle of “The Lithuanian Sunset”. Up to October “The Lithuanian Sunset” is likely to be making a rising profit, which means that by then “The Lithuanian Sunset” would be able to analyse the most popular products and take least popular products off the shelf in order to reduce opportunity costs and stock alternative products. However, such action could reduce consumer loyalty, especially the people who bought those products. November is set to see a great slump in sales, which is likely too be caused by the seasonal trend of saving up for Christmas presents, more luxurious products. In order to increase the feasibility of a Lithuanian shop “The Lithuanian Sunset” should attempt to stock several more luxurious items such as Russian jewellery (fairly rare in England), which could be imported from Lithuania and sold with added value. This could help to boost the sales revenue and maximize the profit margin. Yet, in December the closing balance is predicted to be £1,000 higher as people would be shopping for normal goods needed for Christmas dinner and New Year celebrations. In effect, “The Lithuanian Sunset” should differentiate its stock from its consumers by stocking more festive items such as champagne, Lithuanian cakes and spirits. However, a move towards alcoholic drinks (spirits) could be seen as unethical and even dissuade families from shopping at “The Lithuanian Sunset”; there are also greater taxes attached to alcoholic drinks, which could thus result in a leaner net profit after tax.
Investment Appraisal
According to the payback method of investment appraisal, I and my partner will be able to recover our initial investment of £16, 200, - during the third month of the third year. We have benchmarked this period of payback with other similar businesses, including “The Brother’s Food Store”, and have discovered that we will recover our initial investment 1 year earlier than those businesses. However, the payback method of investment appraisal is based on cash flow forecasts, which are mere predictions into the future, and can be invalidated by the economic climate in the future as well as changes in the Lithuanian demography in Stratford. The payback method also doesn’t show the average rate of return and more importantly net present value, which would measure the future value of return in today’s terms. Lastly and most importantly, the payback method fails to consider qualitative factors involved, such as ethical issues and corporate image of the project that is likely to have an effect on “The Lithuanian Sunset” and so should not be used as a single financial tool for making long-term judgments.
| January | February | March | April | May | June | July | August | September | October | Noveber | December | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| £ | £ | £ | £ | £ | £ | £ | £ | £ | £ | £ | £ | |
| Income | ||||||||||||
| Grant | £500.00 | £0.00 | £0.00 | £0.00 | £0.00 | £0.00 | £0.00 | £0.00 | £0.00 | £0.00 | £0.00 | £0.00 |
| Revenue | £2,000.00 | £3,000.00 | £3,800.00 | £4,800.00 | £6,000.00 | £7,800.00 | £8,600.00 | £9,000.00 | £9,200.00 | £9,000.00 | £9,500.00 | £11,000.00 |
| Owners Capital | £5,200.00 | £1,000.00 | £1,000.00 | £1,000.00 | £1,000.00 | £1,000.00 | £1,000.00 | £1,000.00 | £1,000.00 | £1,000.00 | £1,000.00 | £1,000.00 |
| Total Income | £7,700.00 | £4,000.00 | £4,800.00 | £5,800.00 | £7,000.00 | £8,800.00 | £9,600.00 | £10,000.00 | £10,200.00 | £10,000.00 | £10,500.00 | £12,000.00 |
| Expenditure | ||||||||||||
| Wages | £3,339.60 | £3,339.60 | £3,339.60 | £3,339.60 | £3,339.60 | £3,339.60 | £3,339.60 | £3,339.60 | £3,339.60 | £3,339.60 | £3,339.60 | £3,339.60 |
| Rent | £700.00 | £700.00 | £700.00 | £700.00 | £700.00 | £700.00 | £700.00 | £700.00 | £700.00 | £700.00 | £700.00 | £700.00 |
| Advertising | £1,200.00 | £1,200.00 | £1,200.00 | £0.00 | £0.00 | £0.00 | £0.00 | £0.00 | £0.00 | £0.00 | £0.00 | £0.00 |
| Stock Purchase | £3,657.63 | £3,657.63 | £3,657.63 | £3,657.63 | £3,657.63 | £4,000.00 | £4,000.00 | £3,500.00 | £3,600.00 | £3,000.00 | £5,000.00 | £5,500.00 |
| Initial Costs | £4,997.48 | £0.00 | `- | £0.00 | £0.00 | £0.00 | £0.00 | £0.00 | £0.00 | £0.00 | £0.00 | £0.00 |
| Utility Bills | £560.00 | £560.00 | £560.00 | £560.00 | £560.00 | £560.00 | £580.00 | £580.00 | £580.00 | £580.00 | £580.00 | £580.00 |
| Total Expenditure | £14,454.71 | £9,457.23 | #VALUE! | £8,257.23 | £8,257.23 | £8,599.60 | £8,619.60 | £8,119.60 | £8,219.60 | £7,619.60 | £9,619.60 | £10,119.60 |
| Opening Balance | £0.00 | -£6,754.71 | -£6,257.23 | -£4,957.23 | -£2,457.23 | -£1,657.60 | -£1,399.60 | £280.40 | £1,080.40 | £1,280.40 | £1,880.40 | £380.40 |
| Closing Balance | -£6,754.71 | -£5,457.23 | #VALUE! | -£2,457.23 | -£1,257.23 | £200.40 | £980.40 | £1,880.40 | £1,980.40 | £2,380.40 | £880.40 | £1,880.40 |
