5.5 Cash and cash flow

Importance of Cash to a Business

Cash is crucial for a business as it provides liquidity, enabling the business to meet its short-term debts and expenses. It ensures that the business can pay its bills, wages, and suppliers, and continue its operations smoothly.

Difference Between Cash and Profit

• Cash: The actual money a business has on its premises or in its bank accounts. It is used to pay immediate expenses and debts.

• Profit: The difference between sales revenue and production costs. A business can be profitable but still face cash shortages if its cash flow is not managed well.

Usefulness of Cash Flow Forecasting to a Business

Cash flow forecasting is a vital tool for businesses, helping them plan and manage their finances effectively. It involves predicting the flow of money into and out of the business over a certain period.

Key Benefits of Cash Flow Forecasting:

1. Planning Tool: Helps a business know if it will have enough liquidity to pay its bills.

2. Anticipating Cash Shortages: Identifies periods when the business might face cash shortages and allows for early planning to address these issues.

3. Dealing with Negative Cash Flow: Suggests ways to manage cash shortages, such as arranging for finance or reducing spending.

4. Providing Targets: Helps set cash flow targets to ensure the business can meet its financial obligations.

Use	Explanation
Planning tool	A cash flow forecast is a plan which helps a business know if it will have enough liquidity to pay bills.
Anticipating shortages	Shows when the business might have a cash shortage, enabling it to plan how to address this.
Dealing with shortages	Suggests methods to handle cash shortages, like arranging finance or cutting costs.
Providing targets	Helps set financial targets, ensuring the business can meet its obligations during cash flow issues.

Steps to Complete a Cash Flow Forecast:

1. Total Inflow: Add all cash inflows for the month.

2. Total Outflow: Add all cash outflows for the month.

3. Net Cash Flow: Subtract total outflows from total inflows.

4. Closing Balance: Add the net cash flow to the opening balance to get the closing balance for the month. This closing balance becomes the opening balance for the next month.

Example of a forecast diagram: