The importance of cash to a business (to pay suppliers, overheads and employees, and to prevent insolvency), the difference between cash and profit, and the calculation and interpretation of cash-flow forecasts (cash inflows, cash outflows, net cash flow, opening and closing balances).

What this dot point is asking

Edexcel wants you to explain why cash is vital to a business, how cash differs from profit, and how to construct and interpret a cash-flow forecast, including net cash flow and the opening and closing balances.

Why cash matters

Cash is what keeps the doors open day to day. A business that cannot pay its bills, wages and suppliers when they are due is insolvent, and insolvency, not a lack of profit, is the most common immediate cause of small-business failure. This is why Edexcel treats managing cash as a survival issue, especially for start-ups and seasonal businesses whose income is uneven.

Cash versus profit

The difference is timing. Profit is recorded when a sale is made, even if the customer pays 60 days later; cash only counts the money when it actually arrives. So a manufacturer can win a large, profitable order but pay for the materials and labour weeks before the customer settles the invoice. In that gap it needs cash to keep trading. Three things commonly cause a profitable business to run short of cash:

• giving customers credit, so sales are made but the cash arrives late,
• overtrading, where a fast-growing business buys ever more stock before the cash from earlier sales has come in,
• tying cash up in stock or equipment, money now sitting on shelves or in machinery rather than the bank.

A worked feel for the gap: a firm sells goods for $50{,}000$ in March that cost $30{,}000$ to make. The profit is $20{,}000$. But if it paid the $30{,}000$ to suppliers in March and the customer pays in May, the firm is $30{,}000$ down in March and April even though the deal is profitable. That two-month cash gap is what a forecast exposes.

The cash-flow forecast

Reading a forecast is about spotting the lowest closing balance and acting before it turns negative. A forecast is only an estimate, so its weakness is that real inflows can be lower and outflows higher than predicted; sensible businesses build in a buffer. If a forecast shows a negative closing balance ahead, the business can arrange an overdraft, chase customers to pay sooner, delay payments to suppliers, or cut costs before the shortage hits.

Try this

Q1. A month has inflows of $5{,}000$ and outflows of $6{,}000$. State the net cash flow. [1 mark]

• Cue. $5{,}000 - 6{,}000 = -1{,}000$.

Q2. Explain one action a business could take if its forecast shows a negative closing balance next month. [3 marks]

• Cue. Arrange an overdraft, chase customers to pay sooner, delay supplier payments, or cut costs, with a brief reason.