How does a business forecast its cash and avoid running out of money?
The purpose and preparation of a cash flow forecast, the difference between cash and profit, the identification of cash surpluses and deficits, and the methods of improving cash flow.
A focused answer to AQA A-Level Accounting 3.2, covering the purpose and preparation of a cash flow forecast, the difference between cash and profit, the identification of surpluses and deficits, and the methods of improving cash flow.
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What this dot point is asking
AQA wants you to prepare and interpret a cash flow forecast, explain the difference between cash and profit, identify cash surpluses and deficits, and suggest ways to improve cash flow. This is unit 3.2.6, and a multi-month cash flow forecast that rolls the closing balance forward is a standard Paper 2 preparation task.
Purpose and preparation
The structure is consistent: for each period, list receipts (cash sales, receipts from credit customers, loans, capital introduced), total them, list payments (purchases, wages, rent, capital spending, loan repayments, drawings), total them, and find the net cash flow (receipts minus payments). Add the net cash flow to the opening balance to get the closing balance, which then becomes the next period's opening balance. This roll-forward is the part examiners check most closely.
Cash versus profit
This distinction is the conceptual heart of the unit. Depreciation, for example, reduces profit but never appears in a cash flow forecast, because no cash leaves the business when it is charged. Conversely, buying a machine for cash is a large outflow in the forecast but only enters profit gradually as depreciation. Rapid growth (overtrading) is a classic trap: sales and profit rise, but cash is swallowed by extra inventory and receivables faster than it returns.
Worked forecast
Improving cash flow
When a forecast shows a deficit, options include arranging an overdraft or short-term loan, chasing receivables and tightening credit control, negotiating longer credit terms with suppliers (within agreement), reducing inventory, leasing rather than buying assets, and rescheduling or delaying capital spending. Each improves the timing of cash without necessarily changing profit, which is why the cash-versus-profit distinction underpins the whole topic.
Try this
Q1. State the formula linking opening balance, net cash flow and closing balance. [1 mark] .
Q2. Suggest two ways a business could improve its cash flow. [2 marks] For example chasing receivables faster and negotiating longer supplier payment terms.
Exam-style practice questions
Practice questions written in the style of AQA exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
AQA 20198 marksA business starts January with 20,000 in January, 26,000 in March. Payments are 24,000 and $19,000 respectively. Prepare the cash flow forecast for the three months, showing net cash flow and the closing balance each month.Show worked answer →
A full worked three-month forecast; the closing balance must roll forward.
January: net cash flow = 20,000 - 22,000 = -3,000.
February: net cash flow = 18,000 - 24,000 = -3,000 (an overdraft).
March: net cash flow = 26,000 - 19,000 = +4,000.
Markers reward the correct net cash flow each month, carrying the closing balance forward as the next opening balance, and identifying the February deficit. The standout point is that the business is overdrawn in February and must arrange finance in advance.
AQA 20215 marksA profitable business is running out of cash. Analyse the possible reasons and recommend two ways to improve its cash flow.Show worked answer →
A 5-mark "Analyse and recommend" answer separates cash from profit.
Reasons: a profitable business can lack cash because of generous credit given to customers, holding too much inventory, large capital spending or loan repayments, or rapid expansion (overtrading) that ties cash up in working capital; profit includes credit sales and excludes capital outflows (2 to 3 marks).
Recommendations: tighten credit control and chase receivables faster; negotiate longer supplier terms or arrange an overdraft; reduce inventory or lease rather than buy assets (2 marks). Markers reward explaining why profit and cash differ and giving practical, justified actions.
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Sources & how we know this
- AQA A-level Accounting (7127) specification — AQA (2017)