6.2 Cashflow

What is cash?

Money a business has which is immediately available to spend
It can be physical (notes and coins), but also available for immediate withdrawal or transfer from a bank
Cash is used to pay bills, e.g. Wages and suppliers (including rent and utilities)

Liquidity is how quickly a business can get its hands on its cash.

Cash Inflow

Diagram of cash flowing in to a business

Cash flows in to a business from:

Sale of goods and services
Loans from banks
Money from investors

Cash Outflow

Cash flows out of a business from:

Buying supplies
Wages
Rent
Interest on loans
Taxes

Net Cashflow

Net cashflow is the difference between cash inflow and cash outflow over time.

Net Cash Flow = Cash Inflow – Cash Outflow

A positive net cashflow means more money is coming into the business than flowing out of it. This allows a business to meet its payment obligations on time.

A negative net cashflow means that a business will struggle to meet its payment obligations on time. This can have serious consequences for the business, and could cause it to fail

Cashflow vs Profit

Cashflow is not the same as profit.

A business may sell lots of goods, and make a healthy profit, but if it needs to pay suppliers before it receives payment from customers, it will have a negative cash flow.

Poor cashflow is a serious problem for businesses because they may not be able to afford to pay staff, suppliers, or lenders.

Staff may then refuse to work, suppliers will refuse to supply the firm in the future, and legal action may be taken to try to recover owed payments.

Overcoming Negative Cashflow

If a business has negative cashflow, two common short-term options are:

Use retained profit

This could impact other immediate spending

Get a short-term loan

E.g., an overdraft — but this could be expensive

Improving Cashflow

A business can improve its cashflow by:

Negotiating longer trade credit from its suppliers
Offering shorter trade credit to its customers
Rescheduling its other cost repayments so they do not fall throughout the month

A cashflow forecast can help to anticipate and plan for problems.

Cashflow Forecast

A business will budget for:

What it expects its inflows to be
What it expects its outflows to be

This allows it to anticipate liquidity problems (when it does not have access to cash). It can then plan ahead and try to arrange to have enough cash when it is needed.

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Cashflow Forecast Pros and Cons

Pros

Useful for predicting liquidity problems
Allow a business to make borrowing arrangements if necessary

Cons

Accurately predicting revenue and spending can be tricky
Inflows and outflows must be monitored very carefully in case of unexpected costs or lower than predicted revenue