Nature and sources of cash - Cash flow drivers and seasonali...

Learning Outcomes

After reading this article, you will be able to explain the main sources of business cash, identify and evaluate the drivers of cash flows, and describe how seasonality affects cash requirements. You will also learn to distinguish operating, investing, and financing cash flows, and to analyse the challenges of managing cash resources during periods of fluctuating demand.

ACCA Foundations in Financial Management (FFM) Syllabus

For ACCA Foundations in Financial Management (FFM), you are required to understand the identification and management of business cash flows. This article is relevant to the following syllabus areas:

• Distinguishing between cash and profit, and the need for cash management
• Identifying main sources and uses of cash within an entity
• Understanding cash flow categorisation (operating, investing, and financing activities)
• Recognising the main factors (drivers) that influence cash inflows and outflows
• Explaining how seasonality can affect cash flow patterns and liquidity planning

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. Which of the following is NOT a primary driver of a business's operating cash flow?
   1. Inventory turnover
   2. Seasonal sales peaks
   3. Depreciation expense
   4. Receivables collection speed
2. Which activity would most likely be classified as an investing cash flow?
   1. Paying staff salaries
   2. Selling an old delivery van
   3. Borrowing funds from a bank
   4. Issuing shares to new investors
3. How could seasonality typically affect the cash position of a retailer?
   1. Cash receipts and payments remain stable all year
   2. Cash inflows peak just before major public holidays
   3. Cash needs are lower during high sales periods
   4. Seasonality only impacts inventory, not cash

4. Briefly explain the difference between an operating cash flow and a financing cash flow.

Introduction

Every business depends on cash, and its availability often determines whether day-to-day operations continue smoothly. Unlike profit, which is an accounting measurement, cash represents physical liquidity—bank balances and on-hand funds—used to settle obligations as they arise. Understanding where cash comes from, how it moves through a business, and how factors such as seasonality can cause cash shortages or surpluses is essential for successful financial management.

This article discusses the main types and sources of business cash, explains the concept of cash flow drivers, and highlights how seasonal changes in a company’s operations can create additional cash management challenges.

Key Term: cash flow
The net movement of cash into and out of a business over a specific period, resulting from operating, investing, and financing activities.

Key Term: liquidity
The ability of a business to meet its short-term obligations when they fall due, using available cash resources.

NATURE AND SOURCES OF BUSINESS CASH

Businesses obtain and use cash from various sources, each with distinct implications for planning and control.

Main Sources of Cash

Entities generate cash from several activities:

• Operating activities: These relate to the core revenue and cost cycles, such as cash received from customers, and cash paid to suppliers and employees.
• Investing activities: Cash inflows and outflows from buying and selling non-current assets (e.g., machinery, vehicles, property).
• Financing activities: Movements of cash arising from owners or lenders—such as loans received, repayments made, share issues, and dividends paid.

Key Term: operating activities
The principal revenue-producing actions of an entity, and cash flows not classified as investing or financing.

Key Term: investing activities
Activities related to the acquisition and disposal of non-current assets and investments not held for trading.

Key Term: financing activities
Activities that change the size and composition of an entity’s equity and borrowings, such as loans, share issues, or repayments.

Other Sources

• Bank overdrafts, loans, and credit facilities
• Additional capital injected by owners or shareholders
• Sale of surplus assets

Cash may also be generated from reductions in working capital, for example, by collecting debts faster or reducing inventory levels.

CASH FLOW DRIVERS

Cash flow drivers are the factors that directly impact the timing and amount of cash entering or leaving the business. Understanding these helps managers forecast, plan, and control liquidity.

Key Drivers of Inflow and Outflow

• Sales volume and receipts: Higher sales generally generate more cash, but only if customers pay promptly.
• Receivables management: Faster collection from customers improves cash inflow. Extending credit can delay receipt of cash.
• Inventory management: High inventory ties up cash. Frequent, faster inventory turnover releases cash sooner.
• Payables management: Delaying payments to suppliers (within agreed terms) preserves cash but may risk supplier relationships.
• Capital expenditure: Purchasing non-current assets causes large cash outflows.
• Loan repayments and finance costs: Servicing debt leads to routine outflows that must be planned for.
• Dividend payments: Outflows that reduce available business cash.

The Impact of Business Policy

Internal policies, such as offering longer customer payment terms, giving discounts for early payment, or negotiating supplier payment schedules, will all affect the timing and amount of business cash flows.

Worked Example 1.1

A manufacturer typically allows customers 60 days to pay, but its suppliers require payment in 30 days. Sales have increased by 20% this quarter, but receivables are at record highs.

Question: What cash flow issue may arise, and what could the manufacturer do?

Answer:
The business faces a cash shortfall, because cash inflows (receipts from customers) are slower than cash outflows (payments to suppliers). Despite higher sales, cash is tied up in receivables. The company could try to speed up customer collections or negotiate longer payment terms with suppliers to improve cash flow.

SEASONALITY AND CASH FLOW PATTERNS

Seasonality means that a business’s activities fluctuate in a predictable pattern over the months of a year. This pattern strongly affects cash inflows and outflows.

Characteristics of Seasonal Cash Flows

• Peaks: Businesses (such as retailers or holiday services) may have high sales during certain months, leading to large inflows. However, significant outflows may be required in advance for stock purchases, marketing, or temporary staff.
• Troughs: Off-peak periods see lower sales and receipts, but fixed costs (rent, salaries, utilities) typically continue. This can cause cash outflows to exceed inflows.

Key Term: seasonality
The regular, predictable changes in business activity levels and customer demand occurring at certain times of the year.

Effects on Cash Management

• Cash surpluses in peak periods may quickly be used up during off-peak periods.
• Businesses must plan for enough liquidity to cover costs when inflows are low.
• Inventory and staff management are critical in seasonal industries to avoid overcommitting cash.

Worked Example 1.2

A garden equipment retailer does 60% of its annual sales in April to June. The business must pay for inventory and delivery in February.

Question: What seasonal cash flow challenge arises, and how might planning address it?

Answer:
The retailer needs to fund large inventory purchases months before sales revenues are received, leading to a cash outflow well ahead of corresponding inflows. Management could arrange a short-term bank overdraft or delay certain payments until sales receipts begin, ensuring liquidity through the seasonal cycle.

Exam Warning

Be able to distinguish, in exam questions, between an entity with consistent cash flows year-round and one affected by seasonality. Understanding how each influences cash management strategies is frequently tested.

CASH FLOW FORECASTING AND LIQUIDITY PLANNING

Effective businesses plan future cash flows, particularly when seasonality or other drivers create variability.

• Cash flow forecasts help identify periods of cash surplus or shortage in advance.
• Careful monitoring allows managers to arrange financing (e.g., temporary loans or overdrafts) only when necessary.
• Reviewing and adjusting credit policies, payment terms, or planned expenditures can smooth out shortfalls.

Key Term: cash flow forecast
A projection of the expected cash receipts and payments for a future period, used to identify upcoming liquidity needs or surpluses.

Summary

Cash comes from operating, investing, and financing activities. The timing and magnitude of cash inflows and outflows are governed by cash flow drivers such as sales, receivables, payables, and investment purchases. Seasonality introduces predictable fluctuations in cash needs, making advance planning essential to maintain liquidity.

Key Point Checklist

This article has covered the following key knowledge points:

• Explaining the main sources of cash within a business (operating, investing, and financing flows)
• Identifying and evaluating drivers of cash inflows and outflows
• Understanding the impact of seasonality on cash flow patterns and liquidity
• Recognising the importance of cash flow forecasting in managing variable cash needs

Key Terms and Concepts

• cash flow
• liquidity
• operating activities
• investing activities
• financing activities
• seasonality
• cash flow forecast