The Importance of Cash Flow (AQA GCSE Business)

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