Cash and cash-flow

Cash is money a business can use straight away. It includes notes and coins in a till and money in a bank account that can be spent immediately.

Cash flow is the movement of cash into and out of a business over a period, such as a week or a month. Money arriving is a cash inflow; money paid out is a cash outflow.

Why a business needs cash

Cash has to be there when payments are due. A business needs it to pay suppliers for stock and materials, to cover overheads such as rent and electricity, and to pay employees their wages on time.

Timing is the tricky part. Money coming in and money going out rarely happen on the same day. If several bills are due before customers pay what they owe, the business can run short even when it is busy and making sales.

For example, a mobile pet-grooming business might receive £60 from each customer after an appointment. In one week it receives £600 in cash from ten appointments. That same week it must pay £180 for van insurance, £90 for grooming supplies and £230 in wages. The cash coming in is £600 and the cash going out is £500, so the business has £100 more cash at the end of the week. If the insurance payment had been due a week earlier, before the appointments were paid for, the same business could have been short of cash despite having plenty of work booked.

Cash inflows are money received by a business. Cash outflows are money paid out by a business. They are the two directions in which cash moves.

Money coming in

Typical cash inflows include:

• Receipts from sales — money customers actually pay for goods or services.
• Capital introduced — money the owner puts into the business.
• Loans received — money borrowed from a bank or another lender.
• Money from selling assets — for example, selling a delivery van the business no longer needs.

Each of these brings cash into the business, which can then be used to pay bills and staff.

Money going out

Typical cash outflows include payments to suppliers for materials, wages and salaries, rent, utility bills such as electricity and water, other overheads such as insurance or advertising, loan repayments, and payments for stock or assets such as a new computer.

These payments are necessary to keep trading, but each one reduces the cash the business holds. For a small bicycle repair business, one week can bring both:

Cash is the money a business has available at a point in time — notes and coins in the till and money in its bank account. Profit is what is left when you subtract total costs from revenue over a period, such as a month or a year. They are not the same thing, and a business has to keep an eye on both.

Profitable but short of cash

A business can make a profit and still run out of cash. Imagine a pottery studio sells £4,000 of mugs in a month but agrees that the shops buying them will pay 60 days later. The studio records those sales as revenue and, if its total costs were £3,000, shows a £1,000 profit. Yet no cash has arrived, so it may struggle to pay the electricity for its kiln or the wages of the people who make the mugs.

Cash also gets tied up in stock — money spent on clay and glaze that has not yet been sold. And large payments, such as a quarterly rent bill, can fall due before customers pay. Timing is what causes the problem, not a lack of profit.

Cash in that is not profit

Not every cash receipt counts as profit. A bank loan, capital the owner puts in, or money from selling an old delivery van all bring cash into the business, but none of them are sales revenue, so none of them count as trading profit. A positive closing balance only shows that cash is available at the end of the period; it does not mean the business has made a profit.

A cash-flow forecast is a prediction of the cash a business expects to receive and pay out over a future period, often month by month. The cash coming in is recorded as cash inflows and the cash going out as cash outflows.

One of its main purposes is to give early warning. By predicting when cash shortages or cash surpluses are likely, a business can plan ahead instead of reacting when a problem has already happened. Without a forecast, an owner might only discover a shortage when a bill cannot be paid. If the forecast shows a shortage, the owner can arrange short-term finance, such as an overdraft, before the money is needed, delay a planned purchase or chase late payments. If a surplus is expected, they can plan how and when to spend it.

Here is a bakery's forecast of its cash movements for the next three months.

In February, the forecast suggests more cash will go out than come in. The bakery can act in January by arranging short-term finance or moving a planned oven repair to March. Checking the forecast in advance helps it pay running costs such as wages, rent and energy bills, reducing the risk of business failure.

Limitations

Cash-flow forecasts are estimates. Actual sales may be lower, costs may be higher, or a customer may pay later than expected, so the forecast may be inaccurate. A forecast shows cash movements only; it does not calculate profit or break-even.

Net cash flow is the cash coming into a business minus the cash going out during the same period. It compares cash inflows (money received) with cash outflows (money paid out). The formula is:

Net cash flow = cash inflows − cash outflows

A positive answer is a cash surplus: more cash came in than went out during that period. A negative answer is a cash deficit: more cash went out than came in. For example, a mobile bike repair service receives £3,200 from customers in a month and pays £3,750 for parts, fuel and wages. Its net cash flow is £3,200 − £3,750 = −£550, so it has a cash deficit of £550 for that month.

Several periods

To find total net cash flow over several periods, add the net cash flow for each period. You can also take total cash inflows for the whole time and subtract total cash outflows; both methods give the same answer.

Adding the monthly figures gives £500 + (−£400) + £500 = £600. Using the totals gives £6,900 − £6,300 = £600. A deficit in one month is cancelled out by a bigger surplus in another, so the total can look healthy even when one month runs short.

When you calculate net cash flow, write out the formula, put in the figures and show each step of your working, using a calculator if your exam allows it.

The opening balance is the amount of cash a business has available at the start of a period, such as a month. It is not new money: it is the closing balance from the period before, carried forward.

Working out the closing balance

The closing balance is the cash left at the end of the period. You calculate it as:

Closing balance = opening balance + net cash flow

Net cash flow is the change in cash during the period. If net cash flow is positive, the closing balance rises above the opening balance. If it is negative, the closing balance falls.

For example, a bike repair shop starts April with £850. Its net cash flow for April is +£320, so its closing balance is £850 + £320 = £1,170. That £1,170 becomes May's opening balance. In May the shop has net cash flow of -£380, giving a closing balance of £1,170 - £380 = £790. In June, net cash flow is -£900, so the closing balance is £790 - £900 = -£110.

A negative closing balance

A closing balance can be positive or negative. A negative closing balance is a cash deficit: the business has run out of cash by the end of the period. It may still have payments to make, so it may need short-term finance, such as an overdraft, to cover them until more cash comes in.

The closing balance is not the same as net cash flow: net cash flow is the change during the period, while the closing balance is the opening balance plus that change. A positive closing balance means the business has cash available at that point, and it becomes the opening balance for the next period.

Negative cash flow happens when more cash leaves a business than comes in during a period, so the cash it holds falls. Even a busy business can be caught short if payments out fall due before money from customers arrives.

Running costs and debt

A business with negative cash flow may struggle to pay its running costs – everyday bills such as rent, energy, insurance and wages. These fall due on set dates whether or not cash has come in.

If it cannot pay on time, it may ask suppliers to wait for payment or use other credit, and the money it owes is debt. Debt carries risk: interest may be charged, supplier relationships can be damaged, and a business that cannot repay what it owes may fail.

Short-term finance and interest

One way to cover a cash shortage is short-term finance, such as an overdraft, which lets a business spend more than it holds in its bank account for a short while. The catch is interest: the longer the overdraft is used and the larger the amount, the more the borrowing costs, so interest is an extra expense on top of the original bills.

For example, a mobile bike repair service takes £3,500 in a quiet month but pays out £4,200 on parts, van fuel and insurance – negative cash flow of £700. It covers the gap with its overdraft, then pays interest the next month, money that could have gone on new tools.

Employees not paid on time

Wages must be paid on the agreed date. If payday is missed, staff lose trust in the business. Some look for an employer that pays reliably, while others stay but put in less effort, so jobs take longer and customers wait. Hiring and training a replacement drains cash further, and while a post is empty the business may pay an agency a higher hourly rate to cover the work – so one late wage bill can leave a bigger hole than the wages themselves.