Cash flow vs profit
Profit is the difference between revenue and costs over a period. Cash flow is the actual movement of money in and out of the business right now. A business can be profitable on paper but still run out of cash. This happens when money is owed to them (receivables) but bills need paying immediately.
Example: A construction company completes a £50,000 project in January. The client pays in March. But wages, materials and rent are due in January and February. Despite being profitable, the company may not have enough cash to survive until March.
Cash flow forecast
A cash flow forecast predicts the money coming in and going out over a future period, usually monthly for the next 12 months. It has three sections:
- Cash inflows — sales revenue, loans received, investment, asset sales.
- Cash outflows — rent, wages, materials, utilities, loan repayments, tax.
- Net cash flow — inflows minus outflows. If negative, the business is spending more than it receives that month.
The closing balance (cash at the end of the month) becomes the opening balance for the next month. If the closing balance goes negative, the business needs additional funding.
| Jan | Feb | Mar | |
|---|---|---|---|
| Opening balance | £5,000 | £2,000 | −£1,000 |
| Cash inflows | £8,000 | £6,000 | £12,000 |
| Cash outflows | £11,000 | £9,000 | £7,000 |
| Net cash flow | −£3,000 | −£3,000 | £5,000 |
| Closing balance | £2,000 | −£1,000 | £4,000 |
In February, the closing balance is negative. The business needs to arrange an overdraft, delay a payment, or chase customer payments to survive.
Causes of cash flow problems
- Late customer payments — the most common cause. Offering 30 or 60 day credit means waiting for money.
- Overtrading — growing too fast. Taking on more orders than you can fund.
- Seasonal demand — ice cream shops earn most of their revenue in summer but pay rent all year.
- Poor stock management — too much money tied up in unsold inventory.
- Unexpected costs — equipment breakdowns, legal disputes, tax bills.
Improving cash flow
- Chase debtors — send invoices immediately and follow up. Offer a small discount for early payment.
- Negotiate longer payment terms — pay suppliers in 60 days instead of 30.
- Reduce stock levels — use just-in-time (JIT) stock management.
- Arrange an overdraft — provides a safety net for short-term dips.
- Sale and leaseback — sell an asset (like a vehicle) and lease it back. Frees up cash immediately.
- Cut costs — review subscriptions, switch suppliers, reduce waste.
Exam tip: A common exam question is “Explain why a profitable business might experience cash flow problems.” The key is to explain the timing difference between when costs are paid and when revenue is received.