Cash vs profit, inflows and outflows, forecasting, and solving problems
💵 Finance essential⏱ 16 min📝 3 practice questions
Learning Objectives
By the end of this lesson you will be able to…
Explain the difference between cash and profit
Identify examples of cash inflows and outflows
Read and complete a cash flow forecast
Evaluate solutions to cash flow problems
Critical Distinction
Cash vs Profit
Cash
Money physically available to the business right now — in the bank or as notes. Used to pay day-to-day expenses.
Profit
The surplus after all costs are deducted from revenue. A business can be profitable but run out of cash.
Key scenario: A business makes a £50,000 sale on credit — it records profit now, but if the customer pays in 90 days, there's no cash yet. Meanwhile, the business still needs to pay wages next week. This is a classic cash flow problem despite being profitable.
Cash Movements
Cash Inflows & Outflows
Cash Inflows (money coming IN)
Cash sales to customers
Payments received from credit customers
Bank loans received
Share capital from new investors
Sale of old assets (equipment, vehicles)
Government grants
Cash Outflows (money going OUT)
Wages and salaries to staff
Rent and utility bills
Purchases of stock / raw materials
Loan repayments to bank
Tax payments (Corporation Tax, VAT)
Buying new equipment / machinery
Net cash flow = Total inflows − Total outflows (positive = surplus, negative = deficit)
The Forecast
Cash Flow Forecast — Structure
Item
Jan
Feb
Mar
Cash Inflows
Cash sales
8,000
10,000
12,000
Other inflows
2,000
0
0
Total Inflows
10,000
10,000
12,000
Cash Outflows
Wages
5,000
5,000
5,000
Rent & bills
2,500
2,500
2,500
Stock purchases
4,000
3,000
4,000
Total Outflows
11,500
10,500
11,500
Net Cash Flow
(1,500)
(500)
500
Opening Balance
3,000
1,500
1,000
Closing Balance
1,500
1,000
1,500
Closing balance = Opening balance + Net cash flow. The closing balance of one month becomes the opening balance of the next.
Problems
Common Cash Flow Problems
Customers paying late (credit terms): Selling on 60-day credit means money owed doesn't arrive for 2 months — but wages must be paid now.
Overtrading: Rapid growth requires heavy investment in stock and staff before revenue catches up — common cause of start-up failure.
Seasonal demand: A ski resort earns most revenue in winter — it must maintain cash through quiet summer months.
Unexpected costs: Equipment breakdown, emergency repairs, legal costs — sudden large outflows drain the cash reserve.
Poor forecasting: Overestimating sales or underestimating costs leads to planned cash running out faster than expected.
Solutions
Solutions to Cash Flow Problems
Bank overdraft: Short-term borrowing — flexible but high interest rates. Good for temporary shortfalls.
Invoice factoring: Sell invoices (debts owed) to a factoring company for immediate cash — at a discount (lose 5–15%).
Tighten credit control: Chase customers to pay sooner; offer early payment discounts; reduce credit terms from 60 to 30 days.
Negotiate supplier credit: Ask suppliers to extend payment terms — pay in 60 days instead of 30 to keep cash longer.
Increase revenue: Run promotions, introduce deposits, offer discounts for cash payments.
Practice Question 1 of 3
A business made £80,000 profit last year but is struggling to pay its suppliers this month. What is the most likely explanation?
AThe business has made accounting errors
BMost of its sales were on credit, so cash has not yet been received
CThe business has not paid any taxes
DThe business must be operating at a loss
Correct: B. This illustrates the key difference between cash and profit. A business can be profitable but have a cash flow problem if customers buy on credit — the revenue is recorded as profit, but actual cash hasn't arrived yet. Meanwhile, the business must pay its own bills with money it doesn't have.
Practice Question 2 of 3
A business's opening balance in March is £2,000. Total inflows are £9,000 and total outflows are £11,500. What is the closing balance?
A£(500)
B£(2,500)
C£(2,000)
D£11,000
Correct: A — £(500). Net cash flow = £9,000 − £11,500 = −£2,500. Closing balance = Opening balance + Net cash flow = £2,000 + (−£2,500) = −£500. The negative closing balance (in brackets) means the business is overdrawn by £500 at the end of March.
Practice Question 3 of 3
A retail business is experiencing cash flow problems because customers are taking 90 days to pay their invoices. Which solution would most directly address this problem?
AHiring more staff to improve customer service
CReducing the credit period offered to customers from 90 to 30 days
BLaunching a new product range
DIncreasing advertising expenditure
Correct: B. The problem is that customers are taking too long to pay. Reducing the credit period means cash is received sooner, directly improving cash flow. The other options may grow the business long-term but don't solve the immediate timing mismatch between inflows and outflows.
Summary
Cash Flow Essentials
Key formulas
Net cash flow = Inflows − Outflows
Closing balance = Opening balance + Net cash flow
Closing balance → next month's opening balance
Cash ≠ Profit
A profitable business can go bust due to poor cash flow. Cash is needed NOW to pay wages, rent and suppliers. Profit is an accounting measure — cash is reality.
Top 3 solutions to remember
Overdraft — short-term, flexible but costly
Invoice factoring — immediate cash, lose a % of the invoice
Tighter credit control — chase debtors, reduce credit terms