The Importance of Cash Flow (AQA GCSE Business)
Revision Note
Cash Versus Profit
Profit and cash are different financial terminologies
Profit is the difference between revenue generated and total business costs during a specific period of time
Profit can be an important indicator of a company's financial health and long-term success, as it helps to assess the effectiveness of a company's operations
Cash is measured by taking into account the full range of money flowing in and out of a business
This includes revenue from sales, operating expenses, investments, loans, and any other cash-related transactions
While a company may make a profit, they may lack cash as some customers may not actually have paid them yet
Diagram: profit vs cash flow
Profit and Cash-flow are two distinct terms. A business that does not make a profit in the long run will cease to trade
Cash performs a variety of functions in a business
It is used to cover regular operating expenses such as workers' pay, supplier invoices and overheads such as rent and utility bills
It can also be used to meet unexpected expenses, such as the replacement of broken equipment
A profitable business is likely to fail quickly if it does not have sufficient cash
Cash-poor businesses will struggle to pay suppliers, employees and operating expenses
This is called insolvency
Lifestyle retailer Joules announced plans to liquidate in December 2022 as a result of cash-flow difficulties, despite making a profit of £2.6 million during the previous year
Why Cash Flow is Important
Cash is the 'blood' of a business, as without it, a business cannot survive
It is a liquid asset in the form of notes, coins and money in the bank
A new business may have to pay cash on purchase for all of its supplies until its suppliers trust them enough to provide credit terms (buy now, pay later)
A supplier may then give the business trade credit of 30 or 60 days
This means that the business can receive their stock now and only pay for it in 30 or 60 days; the cash outflow is delayed
As the business sells its products, they receive money generated from the business revenue, which represents a cash inflow
At the end of 60 days, they will pay their supplier (cash outflow), but the firm may still have half of its stock available for sale
More established businesses need to ensure that they manage cash-flow to ensure that they do not run out of money
Cash-flow issues may put the business in a situation where it is
Unable to pay key stakeholders, such as workers and suppliers
Production is likely to cease as workers will not work without pay and suppliers will not supply goods if they are not paid
Unable to pay utility bills and rent
The business could be forced into liquidation and, ultimately, is likely to fail
Examiner Tip
A common misconception is that cash flow is the same as working capital. Working capital represents the amount of money a company has to pay its short-term obligations. Cash flow is the net amount of cash and cash equivalents coming in and out of a company and is represented on the cash flow statement.
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