The Importance of Cash (Edexcel IGCSE Business)
Revision Note
Written by: Lisa Eades
Reviewed by: Steve Vorster
The Purpose of Cash
Cash is the 'lifeblood' of a business as without it a business will likely become insolvent relatively quickly
It is the most liquid form of current asset in the form of notes and coins on a businesses premises as well as money deposited in the bank
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 new business may have to pay cash on purchase for all of its supplies until its suppliers trust them enough to provide trade credit
A supplier may then give the business 30 or 60 days to pay what they owe
Stock is received from a supplier
The business sells its products and receives cash in the form of sales revenue
At the end of the credit period, the supplier is paid
Comparing cash & Profit
Profit and cash are different financial terminologies
Profit is calculated at a specific point in time
While a business may ultimately make a profit, they may lack cash at times because some customers may not actually have paid them yet
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 sustainability 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
Cash-poor businesses will struggle to pay suppliers, meet rent payments or struggle to pay workers
A profitable business is likely to fail if it does not have sufficient cash
E.g. 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
Cash Inflows & Outflows
Cash inflows are sums of money introduced to the business
Examples include money earned from sales, monies received such as loans or owners' capital and interest from investments
Diagram Illustrating the Calculation of net cash flow
Net cash flow is calculated by subtracting cash outflows from cash inflows during a given period of time
Cash outflows are sums of money leaving the business
Examples include payments to suppliers, wages and salaries, loan repayments and advertising expenses
The difference between cash inflows and cash outflows during a period of time is known as the net cash flow
Examiner Tips and Tricks
Remember, cash is not the same as revenue. Revenue is one form of cash inflow that is earned at the point of sale but may not flow into a business at that time. If a business sells products on credit, it earns revenue on the day it is sold but the customer will not pay for, perhaps, 30 days. When they do pay, the business receives cash.
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