The-Importance-Of-Cash

The role of cash

• Cash is the ‘blood’ of a business, as without it, a business cannot survive

  • It is a liquid asset in the form of notes, coins and money in the bank

• A new business may have to pay cash on purchase for all of its supplies until its suppliers trust them enough to provide credit terms (buy now, pay later)

  • A supplier may then give the business trade credit of 30 or 60 days

  • This means that the business can receive their stock now and only pay for it in 30 or 60 days; the cash outflow is delayed

  • As the business sells its products, they receive money generated from the business revenue, which represents a cash inflow

  • At the end of 60 days, they will pay their supplier (cash outflow), but the firm may still have half of its stock available for sale

• More established businesses need to ensure that they manage cash effectively to ensure that they do not run out of money

  • Cash-flow issues may put the business in a situation where it is :

    • Unable to pay key stakeholders, such as workers and suppliers

      • Production is likely to cease as workers will not work without pay and suppliers will not supply goods if they are not paid

      • Unable to pay utility bills and rent

    • The business could be forced into liquidation and is, ultimately, likely to fail

The difference between cash and profit

• Profit and cash are different financial terminologies

  • Profit is the difference between revenue generated and total business costs during a specific period of time

    • Profit can be an important indicator of a company’s financial health and long-term success, as it helps to assess the effectiveness of a company’s operations

  • Cash is measured by taking into account the full range of money flowing in and out of a business

    • This includes revenue from sales, operating expenses, investments, loans, and any other cash-related transactions

• While a company may make a profit, they may lack cash as some customers may not actually have paid them yet

• Cash performs a variety of functions in a business

  • It is used to cover regular operating expenses such as workers’ pay, supplier invoices and overheads such as rent and utility bills

  • It can also be used to meet unexpected expenses, such as the replacement of broken equipment

• A profitable business is likely to fail quickly if it does not have sufficient cash

  • Cash-poor businesses will struggle to pay suppliers, employees and operating expenses

  • This is called insolvency 

    • Lifestyle retailer Joules announced plans to liquidate in December 2022 as a result of cash-flow difficulties, despite making a profit of £2.6 million during the previous year

The usefulness of cash flow forecasting

• A cash flow forecast is a prediction of the anticipated cash inflows and outflows, usually for a six- to twelve-month period

• A detailed business plan usually includes a cash flow forecast that allows the business owners to identify its financial needs

  • It provides evidence for investors or lenders that finance is required

  • It allows owners or managers to make plans to cover cash shortfalls

• Cash flow forecasts are particularly useful in the following situations:

  • Starting up a business: identifying how much cash is needed in the first few months

  • Running an existing business: recognising where a fall in sales may require use of an overdraft facility

  • Supporting applications for borrowing: determining the size of loan or overdraft needed, when and for how long it is needed and by when it is likely to be fully repaid

  • Managing transactions: identifying how much or how little cash is deposited at the bank can determine when bills should be paid