3.7

3.7 - CASH FLOW

Cash is the most liquid asset of the business. It is like the water of the business because it is essential and because it flows. 

Cash flow refers to money coming in and going out of the business. Money coming in are cash inflows, money going out are cash outflows. 

Ideally, businesses should have sufficient cash at any point in time. Cash deficiency might result in insolvency and even bankruptcy, but too much cash might mean that a business is holding too much of a depreciating asset because cash is losing its value over time due to inflation.

Profit is the positive difference between revenue and costs. If this difference is negative (i.e. if costs exceed revenues), it means that a business is experiencing loss. 

Investment (in IB BM course) refers to the purchase of non-current assets that generate future earnings. It can also refer to purchase of stock/shares, M&As and many other things. 


Differences Between Profit and Cash Flow - 

Profit

  • Represents financial gain after expenses.

  • Can include revenue from credit sales.

Cash Flow

  • Measures actual cash coming in and out of the business.

  • Reflects liquidity and ability to cover immediate expenses.

Key Differences 

Profitability with No Cash

  • A business can be profitable while having little or no cash (e.g., sales on credit).

  • Example: Customer buys on credit; profit recorded, but cash received later.

Cash without Profitability

  • A business can have cash inflow without being profitable (e.g., loans).

  • Example: Taking out a loan provides cash but doesn't contribute to profit.

Relationship to Investment

Investment : Refers to allocating resources to generate future returns.

Link to Cash Flow and Profit

  • Investments can impact both cash flow and profit:

  • New equipment may increase future profits but requires immediate cash outflow.

  • Cash flow from investments (like dividends) may not immediately translate to profit.

Cash flow forecast is a document that shows predicted movement of cash in and out of business per time period. Cash flow forecast is a forward-looking document, because it shows a prediction of the future cash flow.

If the same document is backwards-looking and is based on existing past data, then it is called a cash flow statement. Comparing cash flow forecasts with cash flow statement helps businesses to predict their cash flow more accurately and reflect on the performance of the business in terms of cash flow.

Opening balance is the amount of cash at the beginning of the trading period. It equals the preceding month’s closing balance. For example, the opening balance for June is the same figure as May’s closing balance.

Cash inflows come from sales revenue, debtors, loans, interest received, sale of assets, rental income, etc. Anything that refers to money going inside the business is a cash inflow.

Cash outflows are expenses, such as rent, wages, purchase of stocks, tax, creditors, advertising, interest payments, dividends, etc. Outflows are the opposite of inflows, i.e. they are money going out of the business.

Net cash flow is the difference between cash inflows and cash outflows. It needs to be positive to avoid bankruptcy. If net cash flow is negative for a few months in a row, it is a clear indicator of cash deficiency and liquidity problems. Remember that there are also liquidity ratios that serve as indicators of liquidity issues.

Closing balance is the amount of cash at the end of a trading period. In other words, closing balance equals opening balance plus net cash flow.

 TERMS/IMPORTANT STUFF : 

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Opening Balance: The value of cash a business has at the beginning of a trading period, shown in its cash flow forecast or cash flow statement. It equals the previous period's closing balance.

Overtrading: When a business expands too quickly without sufficient resources, often by accepting too many orders, leading to cash flow issues.

Bad Debts: Occur when debtors are unable to pay their outstanding invoices, reducing the cash inflows of the business that sold goods on credit.

Cash: A current asset representing the actual money a business has, either as cash in hand (on-site) or cash at bank (held in a bank account).

Cash Flow: The movement of money into and out of an organisation.

Cash Flow Forecast: A financial tool showing the expected cash inflows and outflows for a business over a given period.

Cash Flow Statement: A financial document that records the actual cash inflows and outflows of a business over a specific period, usually 12 months.

Cash Inflows: Money entering a business during a specific period, usually from sales revenue when customers pay for their purchases.

Profit: The positive difference between a firm’s total sales revenue and its total production costs for a given time period.

Working Capital Cycle: The time between cash outflows for production costs and cash inflows from customers paying for finished goods and services.

Cash Outflows: Money leaving a business during a specific period, such as payments for invoices or bills.

Closing Balance: The amount of cash left in a business at the end of a trading period, calculated as: Closing Balance = Opening Balance + Net Cash Flow.

Credit Control: The process of monitoring and managing debtors, including setting trade credit limits and ensuring timely payments.

Net Cash Flow: The difference between a firm's cash inflows and cash outflows for a given period, usually calculated monthly.