The Importance of Cash to a Business
- Cash is the 'blood' of a business, as without it, a business will die
- It is a liquid asset in the form of notes, coins and money in the bank
- It is a liquid asset in the form of notes, coins and money in the bank
- A profitable business is likely to fail if it does not have sufficient cash
- Cash-poor businesses will struggle to pay suppliers, employees and operating expenses
- This is called insolvency
- 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
- 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 and this 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
- A cash flow cycle shows the stages between paying out cash for labour, materials, and so on, and receiving cash from the sale of goods
Diagram to show a Cash-flow Cycle
Explanation of cash-flow cycle
- The diagram shows that cash is needed to pay for materials used to produce the product
- Time is needed to produce the products before they can be sold to customers
- If customers purchase the goods using a credit facility provided by the business, then they will not have to pay immediately, which will delay cash inflows
- When they do pay for the goods immediately, this money will be used to pay business expenses
- Due to the time between each stage, the business needs to make sure it has enough working capital to keep running and pay bills
- Businesses, particularly start-ups, need to ensure that they manage cash-flow to ensure that it does 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
- Unable to pay key stakeholders, such as workers and suppliers
- The business could be forced into liquidation and, ultimately, is likely to fail