The Importance of Cash Flow (AQA GCSE Business)

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Lisa Eades

Written by: Lisa Eades

Reviewed by: Steve Vorster

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 are different concepts in business. A business may make a profit yet lack cash.

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 Tips and Tricks

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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Lisa Eades

Author: Lisa Eades

Expertise: Business Content Creator

Lisa has taught A Level, GCSE, BTEC and IBDP Business for over 20 years and is a senior Examiner for Edexcel. Lisa has been a successful Head of Department in Kent and has offered private Business tuition to students across the UK. Lisa loves to create imaginative and accessible resources which engage learners and build their passion for the subject.

Steve Vorster

Author: Steve Vorster

Expertise: Economics & Business Subject Lead

Steve has taught A Level, GCSE, IGCSE Business and Economics - as well as IBDP Economics and Business Management. He is an IBDP Examiner and IGCSE textbook author. His students regularly achieve 90-100% in their final exams. Steve has been the Assistant Head of Sixth Form for a school in Devon, and Head of Economics at the world's largest International school in Singapore. He loves to create resources which speed up student learning and are easily accessible by all.