Why cash matters
Cash is money the business holds in notes, coins and its bank account, ready to spend. Cash flow is the movement of cash in and out over time.
A business needs cash to pay wages, suppliers, rent, tax and loan repayments on time. If it cannot, suppliers stop delivering, staff leave and lenders can close the business. More firms fail from running out of cash than from making losses.
But holding too much cash is also wasteful: idle cash earns little. Good cash management (sometimes called treasury management) keeps enough for safety and puts any surplus to work, for example in a short-term deposit or to repay expensive debt.
Inflows, outflows and the cash flow forecast
Cash inflows: cash sales, payments from credit customers (receivables), loans, owner's capital, sale of assets.
Cash outflows: wages, rent, raw materials, bills, loan repayments and interest, tax, buying equipment.
Net cash flow = total inflows − total outflows.
Closing balance = opening balance + net cash flow. The closing balance of one month is the opening balance of the next.
A cash flow forecast is a month-by-month table of expected inflows and outflows. It helps to: spot months with negative balances in advance, arrange an overdraft in time, show a bank the business plan, and compare plans with what really happens.
Limits: it is only a prediction. Sales may fall, costs may rise and customers may pay late.
Cash is not profit
Profit = revenue − costs over a period. It counts a sale when it is made, even on credit.
Cash only counts money when it actually arrives or leaves.
- A profitable firm can run short of cash: customers pay late, it buys lots of stock, or it buys a machine with cash.
- A loss-making firm can have cash for a while: from a loan or by selling assets.
Causes of cash flow problems
- Giving customers long credit; bad debts (customers who never pay).
- Holding too much stock (inventory).
- Overtrading: growing faster than cash allows.
- Seasonal sales (e.g. ice cream, festival goods).
- Poor planning, unexpected costs, big purchases.
Working capital = current assets − current liabilities. It is the cash and near-cash a firm has for day-to-day running.
How to improve cash flow and profit
Short-term ways to cover a gap
- Overdraft: the bank lets the account go below zero up to a limit. Flexible, but interest is high.
- Short-term loan or owner putting in more money.
Speed up inflows
- Chase customers; give less credit time; offer a small discount for paying early.
- Factoring: sell your unpaid invoices to a factoring firm and get most of the cash now (it keeps a fee).
- Sale and leaseback: sell an asset (like a building) and rent it back. Big cash now, but rent to pay for years.
- Sell off unused assets or extra stock.
Slow down outflows
- Ask suppliers for longer credit; lease instead of buying; keep less stock (just-in-time); delay non-urgent spending.
Improving profit
Raise prices (if demand allows), cut costs (cheaper suppliers, less waste), or sell more. Each has risks: higher prices can lose customers; cheaper inputs can harm quality.
Try it
Make a 3-month cash flow forecast for your pocket money. Rows: opening balance, money in (pocket money, gifts), money out (snacks, travel, a planned gift), net cash flow, closing balance. Fill it line by line like the 3D. Is any month negative? What could you change: spend later, save more, or ask for money earlier? Then test the same ideas with the sliders in free play.
Key formulas and definitions
- Net cash flow = cash inflows − cash outflows
- Closing balance = opening balance + net cash flow
- Next month's opening balance = this month's closing balance
- Profit = revenue − costs (counted when sales are made)
- Working capital = current assets − current liabilities
Worked examples
1. Inflows 12,000, outflows 9,500. Find net cash flow.
Net = 12,000 − 9,500 = 2,500.
2. Opening balance 3,000; net cash flow −1,000. Find the closing balance.
Closing = 3,000 + (−1,000) = 2,000. This is next month's opening balance.
3. Complete 2 months. Opening 3,000. Jan: in 3,000, out 4,000. Feb: in 3,000, out 4,500.
Jan: net −1,000, closing 2,000. Feb: opening 2,000, net −1,500, closing 500.
4. A firm has an overdraft limit of 4,000. Its forecast closing balances are −2,500, −4,000, −4,500. Which month is a problem?
Only the third month: −4,500 goes past the −4,000 limit. The first two are inside the limit.
5. A shop makes a profit of 5,000 in March but its bank balance falls. Give two reasons.
Customers bought on credit and have not paid yet; the shop bought a lot of stock (or a machine) with cash in March.
6. A firm sells invoices worth 20,000 to a factor who pays 80% now and charges a 3% fee. How much cash now, and what does the fee cost?
Cash now = 80% × 20,000 = 16,000. Fee = 3% × 20,000 = 600 (taken from the remaining 4,000 when the customer pays, so 3,400 comes later).
Common mistakes
- Treating profit and cash as the same thing. Credit sales add to profit before any cash arrives.
- Forgetting to carry the closing balance forward as the next month's opening balance.
- Adding a negative net cash flow instead of subtracting: 2,000 + (−1,500) = 500, not 3,500.
- Thinking an overdraft is free money. It must be repaid and the interest is high.