Importance of cash

Cash is the money a business has available to spend straight away. It is what the business uses to pay for goods, services and debts as they fall due.

Cash is held either in hand, such as notes and coins in a till or safe, or in a bank account the business can pay from by card or bank transfer. It is more than the physical money in a shop till.

Why a business needs cash

A business always has bills to settle in the short term, whatever its sales or profit figures say on paper. Cash is what pays these everyday costs, such as:

• stock and materials from suppliers
• wages for staff
• rent for a workshop or a market stall
• repayments on a loan
• insurance and other regular bills

These payments are due on set dates, so the money has to be in the business's account at that moment. They must be paid whether or not the business has made a profit, which is why cash is what keeps a business trading from one week to the next.

Suppose you run a small print shop. On Monday your business account holds £400. That week you owe £140 for paper and card, £110 towards the loan on your printer and £60 for business insurance, a total of £310. The cash is there, so all three payments go out on time and you still have £90 for the rest of the week.

Cash is the money a business can use now to make payments. Profit is a calculated surplus: total revenue minus total costs. Cash and profit are not the same thing, and one does not automatically give you the other.

Profit becomes cash only when a customer pays and the payment clears. Suppose a bike repair workshop completes a £500 repair for a local club. Parts and labour cost £300, so the job records £200 profit. If the club is invoiced and pays a month later, that £200 is not cash available during that month. The workshop may look profitable but still have little cash in the bank. Money owed by customers is not cash it can spend yet, even though the sale has been recorded as revenue and has contributed to profit.

A profitable business can also have cash tied up in assets such as stock, tools or premises. Those things may help it trade, but they are not money available to make payments. On the other hand, a business can have cash without being profitable. A shop might receive a £2,000 loan, giving it cash to use, while its current costs are higher than its revenue, so it is making a loss.

A lack of cash means a business does not have enough money available when payments are due. Cash is needed to pay running costs such as rent, utilities and wages, and to pay debts and suppliers on time. If the business does not have enough cash, these payments may be missed or delayed.

Paying running costs and debts

Everyday bills still need paying even when money is tight. A pottery-painting studio might have a waiting list of birthday bookings but no cash in the bank until the deposits clear. Meanwhile the monthly instalment on the kiln it bought on credit falls due, and so does its insurance. Missing those payments puts the equipment and the cover at risk and makes it harder to run the business normally.

Suppliers and stock

A business that cannot pay a supplier may find that the supplier refuses to supply goods or services. If a florist is behind on paying its flower wholesaler, the wholesaler may put the account on hold and stop deliveries, so the florist has no flowers to make up bouquets for a wedding order. Even without a refusal, a cash shortage can stop the business buying resources or stock such as flowers, ribbon and wrapping, so it cannot keep operating.

Cash transactions with customers

A lack of cash can also stop a business carrying out normal cash transactions with customers. A bike repair workshop that has very little cash in its till may be unable to refund a customer who paid in cash for a faulty light. Staff may have to delay the refund or ask the customer to come back another day, which annoys the customer and may lose their future custom.

A cash shortage can cost a business more than the payments it delays. If it pays a lender or supplier late, it may be charged a penalty or an additional charge, such as a late-payment fee. That extra cost has to be paid too, so it uses up cash and makes the shortage worse.

Why repeated late payments matter

Paying late again and again can damage a business's credit rating. This is a score based on how reliably the business has paid money it owes, and lenders use it to judge how risky lending to that business would be. A poor rating makes borrowing harder, or more expensive, because lenders may charge higher interest to cover the risk. For example, a bakery pays a flour supplier £600 ten days late and is charged a £45 fee. If this happens often, a bank may refuse its loan for a new oven or offer it at a higher interest rate.

Actions a cash shortage can force

To ease a cash shortage, a business may have to act: it can borrow more or sell assets to raise funds, or cut costs to reduce spending.

These are difficult financial decisions because each one brings cash in or saves cash now but creates a drawback later. The shortage pushes the business into choices that affect its future finances, not just its ability to make a single payment.

A severe or continuing lack of cash means a business does not have enough cash to pay what it owes, and the problem is not just a temporary shortage. If it continues, the business may not be able to carry on trading.

A serious consequence is insolvency. This means the business cannot pay its debts as they fall due. For example, a small T-shirt printing business owes its blank T-shirt supplier £2,000 today but has only £300 in the bank. It cannot pay, so it is insolvent.

Insolvency can lead to liquidation. The business’s assets, such as printing equipment and stock, are sold to pay debts, and the business is closed. For an individual owner such as a sole trader, bankruptcy is a legal process that can follow when debts cannot be paid. The business may also close, or be forced to stop trading. People or businesses owed money can take legal action to recover it, which can lead to liquidation or bankruptcy.

These outcomes are more serious than a temporary cash problem. They can happen when the business has no realistic way to pay its running costs, debts or suppliers. Insolvency is not the same as making a loss: it is about being unable to pay debts as they become due.