Cash and cash flow

Overview

Cash is often described as the lifeblood of a business. Without it, day-to-day operations grind to a halt. This study guide covers the fundamental importance of cash for maintaining liquidity and meeting short-term debts. We will explore the critical distinction between cash and profit—a concept examiners frequently test—and examine how cash flow forecasting acts as a vital planning tool. By anticipating periods of cash shortage, businesses can put remedies in place before a crisis hits. Listen to the podcast below for a comprehensive overview of the topic:

The Importance of Cash

Cash is the money that a business has immediately available. It exists in two main forms: notes and coins in the till, and money held in bank accounts.

Why it matters: Cash is required for liquidity. A business must be able to pay its short-term debts and expenses, such as wages, supplier invoices, rent, and utility bills. If a business cannot pay these debts when they fall due, it becomes insolvent and may be forced into liquidation, regardless of how successful its products are.

Cash vs Profit

One of the most common pitfalls for candidates is confusing cash with profit. They are entirely different concepts.

Profit is the surplus left over when total costs are subtracted from total revenue over a period of time. It is a measure of financial success.

Cash is the physical money available right now.

The crucial difference: A business can be profitable but still fail due to a lack of cash. For example, if a business sells £10,000 worth of goods on credit, it has generated £10,000 in revenue (and potentially profit), but it has received £0 in cash until the customers actually pay. Meanwhile, the business still has to pay its staff and suppliers. If it runs out of cash while waiting for customers to pay, it fails.

Cash Flow Forecasting

A cash flow forecast is a financial document that predicts the expected cash inflows and outflows over a future period, typically month by month.

The Structure

• Cash Inflows (Receipts): Money entering the business (e.g., sales revenue, loans).
• Cash Outflows (Payments): Money leaving the business (e.g., wages, rent, raw materials).
• Net Cash Flow: Cash Inflows minus Cash Outflows.
• Opening Balance: Cash available at the start of the month.
• Closing Balance: Opening Balance plus Net Cash Flow. (This becomes the Opening Balance for the next month).

Purpose as a Planning Tool

Examiners expect candidates to understand three main purposes of a cash flow forecast:

1. Anticipating Shortages: By looking at the projected closing balances, a business can identify months where it will face a cash deficit (a negative closing balance).
2. Enabling Remedies: Because the shortage is identified in advance, the business has time to arrange a solution. Remedies might include arranging a short-term bank overdraft, negotiating longer payment terms with suppliers, or chasing debtors to pay earlier.
3. Providing Targets: The forecast sets financial targets for revenue and expenditure. Managers can compare actual performance against the forecast to identify variances and take corrective action.