Cash and cash flow
Cash vs profit — a critical distinction
Profit is the surplus of revenue over costs over a period. A profitable business can still run out of cash if the timing of its receipts and payments does not align.
Cash is the money physically available in the business at any given moment — in the bank or as notes/coins.
UK example — a seasonal gift retailer: the business may be profitable over the year but runs very low on cash in January–October because most of its revenue arrives in November–December. It must manage cash flow carefully to survive the off-peak months.
Key principle: "Cash is king." Without cash to pay suppliers, wages, and rent, a business can be forced into insolvency even if it has strong future orders on the books.
Cash-flow forecasts
A cash-flow forecast is a financial document that predicts the expected cash inflows and outflows over a future period (usually monthly).
Structure of a cash-flow forecast:
| Row | Explanation |
|---|---|
| Total inflows (receipts) | All money expected in: sales revenue, loans received, owner's capital injected |
| Total outflows (payments) | All money expected out: rent, wages, materials, loan repayments, marketing |
| Net cash flow | Total inflows − Total outflows for that month |
| Opening balance | Cash available at the start of the month (= last month's closing balance) |
| Closing balance | Opening balance + Net cash flow = cash at end of the month |
Net cash flow = Total inflows − Total outflows
Closing balance = Opening balance + Net cash flow
If the closing balance is negative, the business has a cash deficit and needs to take action.
Common cash-flow problems
- Overtrading: growing too fast, buying stock before receiving payment from customers.
- Seasonal demand: low inflows in off-peak months while fixed costs continue.
- Late-paying customers (debtors): businesses selling on credit may wait 30–90 days for payment.
- Unexpected expenses: large one-off costs (equipment repair, legal fee).
Improving cash flow
- Chase debtors: reduce credit terms offered to customers.
- Negotiate longer credit terms with suppliers: delay outflows.
- Use an overdraft: short-term borrowing to cover a temporary deficit.
- Cut costs: reduce discretionary spending.
- Increase revenue: promotions to boost inflows.
- Lease rather than buy equipment: spreads the cost.
- Inject additional capital: owner puts more money in.
Edexcel examiner note
Edexcel regularly provides a partially completed cash-flow forecast and asks students to:
- Fill in the missing figures (net cash flow, closing balance).
- Explain the significance of a negative closing balance.
- Recommend a way to improve cash flow and justify it for the context.
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