why cash is important to a business

Cash versus profit

Illustrative numbers – A small service firm shows a profit of £2 000 for the month, but only £500 cash is received because most sales were on credit and a £1 800 equipment purchase was paid in cash. The firm is profitable yet may struggle to pay its rent (£1 200). This demonstrates why cash, not profit, determines short‑term survival.

Cash‑flow forecast – definition, period and purpose (AO 2)

A cash‑flow forecast is a projection of cash inflows and outflows over a specified future period (weekly, monthly, quarterly or annually). It enables managers to:

• Identify potential cash deficits before they occur (AO 3).
• Plan the use of any surplus – e.g., invest, repay debt or distribute dividends (AO 4).
• Link cash expectations to the overall budget and operational plans (AO 2).

Key components of a cash‑flow forecast

When preparing a forecast, check each item below. The syllabus requires the listed sub‑categories.

☐ Opening cash balance
☐ Cash inflows
   – Sales receipts (cash sales + collections on credit sales)
   – Loans / overdrafts received
   – Sale of assets
   – Interest and dividends received
☐ Cash outflows
   – Purchases of stock / raw materials
   – Wages and salaries
   – Rent, utilities and other overheads
   – Loan repayments (principal + interest)
   – Tax payments
   – Other expenses (e.g., insurance, marketing)
☐ Closing cash balance
      = Opening balance + Total inflows – Total outflows

Mathematical expression

Blank template for student use (AO 2)

-------------------------------------------------
|               CASH‑FLOW FORECAST               |
| Period: ______________________________________ |
-------------------------------------------------
| Opening cash balance                | £______ |
-------------------------------------------------
|                INFLLOWS                | Amount |
-------------------------------------------------
| Cash sales                           | £______ |
| Collections from credit sales        | £______ |
| Loans / overdrafts received          | £______ |
| Sale of assets                       | £______ |
| Interest & dividends received        | £______ |
| TOTAL INFLLOWS                       | £______ |
-------------------------------------------------
|                OUTFLOWS                | Amount |
-------------------------------------------------
| Purchases of stock / raw materials   | £______ |
| Wages and salaries                   | £______ |
| Rent, utilities & overheads          | £______ |
| Loan repayments (principal + interest)| £______ |
| Tax payments                         | £______ |
| Other expenses (insurance, marketing)| £______ |
| TOTAL OUTFLOWS                       | £______ |
-------------------------------------------------
| Closing cash balance = Opening + IN – OUT | £______ |
-------------------------------------------------

Benefits of preparing cash‑flow forecasts (AO 3)

Typical time‑horizons and when to use them

• Short‑term (weekly or monthly) – day‑to‑day cash management. Scenario: A café prepares a weekly forecast to ensure enough cash to buy fresh produce each morning.
• Medium‑term (quarterly) – seasonal planning and budgeting. Scenario: A clothing retailer forecasts cash for the next three months to prepare for the summer sales peak.
• Long‑term (annual) – feeds into strategic planning and investment appraisal. Scenario: A start‑up projects cash for the next year to decide whether to seek venture capital.

Practical example – step‑by‑step calculation (AO 2)

One‑month cash‑flow forecast for a small retailer.

1. Start with the opening balance: £5 000.
2. Add total inflows: £5 000 + £12 000 = £17 000.
3. Subtract total outflows: £17 000 – £9 500 = £7 500.
4. The result (£7 500) is the closing cash balance for the month.

What‑if scenario

An unexpected repair bill of £2 000 arises in week 3.

• New total outflows = £9 500 + £2 000 = £11 500.
• Re‑calculated closing cash = £5 000 + £12 000 – £11 500 = £5 500.
• Result: the cash surplus falls to £5 500, reducing the amount available for stock replenishment. The business must consider delaying a non‑essential purchase or arranging a short‑term overdraft.

Common pitfalls – self‑check questions (AO 3)

• Did you include the timing difference between a credit sale and the cash receipt? (Timing pitfall)
• Are your sales forecasts realistic, or are they overly optimistic? (Over‑optimistic sales)
• Have you listed every outflow, such as tax payments, loan interest and insurance? (Missing outflows)
• Do you update the forecast each week as actual cash movements become known? (Not updating)

Simple flow‑chart for preparing a cash‑flow forecast (AO 2)

+-------------------+
| Opening cash bal. |
+--------+----------+
         |
         v
+-------------------+       +-------------------+
| Estimate inflows  |-----> |  Total inflows    |
+--------+----------+       +--------+----------+
         |                         |
         v                         v
+-------------------+       +-------------------+
| Estimate outflows |-----> |  Total outflows   |
+--------+----------+       +--------+----------+
         |                         |
         +-----------+-------------+
                     |
                     v
          +-------------------+
          | Closing cash bal. |
          +-------------------+

Summary

Cash is the lifeblood of a business. While profit shows whether the enterprise is generating a surplus, cash determines whether it can meet its day‑to‑day obligations, invest in growth, and maintain credibility with financiers. A well‑prepared cash‑flow forecast equips managers with a proactive tool to monitor liquidity, avoid cash crises, and make informed strategic decisions.