Fig. 1 shows the forecast closing cash balance for Azeem Cycle Repair, a business that services bicycles near a coastal holiday route. The business has high...
Question 1 Report
Fig. 1 shows the forecast closing cash balance for Azeem Cycle Repair, a business that services bicycles near a coastal holiday route. The business has high repair income in summer, but it pays annual insurance and workshop rent during spring. Azeem is considering a loan to make sure the business can pay cash outflows when they are due.
The loan option has an interest charge. Azeem could instead ask suppliers for longer credit or run a promotion for pre-booked summer repairs. He wants to select the option that improves cash flow without damaging the business in the longer term.
(a) Define the term cash flow forecast. [2]
(b) Calculate the minimum finance required to prevent a negative closing cash balance in May. [3]
(c) Analyse two reasons why the forecast balance improves between May and July. [5]
(d) Assess whether Azeem should use a loan to deal with the May cash shortage. [10]
Answer Details
(a) A cash flow forecast is a prediction of a business’s future cash inflows and cash outflows [1] over a stated future period of time [1]. It is about when cash enters and leaves the business, rather than whether the business makes an overall profit. [2 marks]
(b) The May forecast closing balance is 3200. To prevent a negative balance, finance must bring this up to 0:
\[£0-(-£3200)=£3200\]
Minimum finance required = £3200 [3 marks]. A larger amount could be justified only if a clearly calculated safety buffer were added.
(c) Between May and July, summer visitors are likely to increase demand for bicycle repairs [1]. More repairs mean more cash received from customers [1]. Also, annual insurance may already have been paid during spring [1], so later monthly cash outflows are lower [1]. Pre-booked repairs or deposits could provide cash before the repair work is completed [1]. These factors increase net cash flow, causing the forecast balance to rise from 3200 to £4100. [5 marks]
(d) A loan would give Azeem a known sum to cover the £3200 shortage [1]. This could prevent missed rent, wage or supplier payments [1], protecting the business’s credit reputation and relationships with suppliers [1]. If repayments are fixed, the future outflows can be forecast more easily [1].
However, interest increases total cash outflows [1]. Repayments could become difficult if summer repair demand is below forecast [1]. The forecast is already positive in June [1], so a loan may be unnecessary for a short, seasonal shortage. Asking suppliers for longer credit would postpone cash outflows without taking a full loan, although a supplier may refuse or charge more [1]. A promotion for deposits or pre-booked repairs could improve cash inflow, but may reduce the price charged or profit per repair [1].
Judgement: short-term supplier credit, or a small overdraft, is likely to be more suitable than a loan because the shortage is temporary and July’s balance is forecast to be £4100 [1]. A loan is more justified only if Azeem expects a funding need beyond June. [10 marks]
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