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Business · Putting a business idea into practice

Cash and cash flow forecasting

A business can be profitable and still fail if it runs out of cash. This lesson explains why cash matters, how it differs from profit, and how to calculate and read a cash-flow forecast.

  • 9 key terms
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Last Lesson

Answer from memory before the answers appear.

  • What is break-even?

    The point where total revenue equals total costs.

  • How do you calculate break-even output?

    Fixed costs ÷ (sales price - variable cost per unit).

  • What is the margin of safety?

    Actual sales - break-even output.

  • What happens to break-even if fixed costs rise?

    It rises - more units must be sold.

Learning Objectives

  1. 1Explain the importance of cash to a business.
  2. 2Explain the difference between cash and profit.
  3. 3Explain cash inflows, cash outflows and net cash flow.
  4. 4Calculate opening and closing balances in a cash-flow forecast.
  5. 5Interpret a cash-flow forecast.

THE BIG IDEA

Profit keeps a business going in the long run. Cash keeps it alive this week.

More businesses fail because they run out of cash than because they never make a profit.

Why Cash Matters

Cash is the money a business has available to spend right now - in the bank or in the till.

  • To pay suppliers

    Without cash, suppliers stop delivering stock and materials, and the business cannot sell anything.

  • To pay overheads

    Rent, electricity and insurance must be paid on time, or the business may lose its premises.

  • To pay employees

    Staff expect to be paid on time; if they are not, they may leave.

  • To prevent business failure

    A business that cannot pay its debts when they are due is insolvent, and may be forced to close - even if it is profitable on paper.

Cash or Profit?

Cash

  • The money the business actually has right now.
  • Needed to pay bills when they are due.
  • Changes the moment money comes in or goes out.
  • Short term: without it, a business can fail this month.

Profit

  • Revenue minus costs over a period of time.
  • Includes sales that customers have not yet paid for.
  • Worked out at the end of a period.
  • Long term: without it, a business cannot survive for ever.

How a Profitable Business Runs Out of Cash

Profit counts a sale when it is made; cash counts it when the money arrives.

  • Customers pay late

    A business that lets customers pay in 60 days has made the sale, and the profit, but has none of the cash yet.

  • Paying for stock up front

    A toy shop buys its Christmas stock in September, months before customers buy it.

  • Buying equipment

    A large purchase such as a van uses up cash immediately, even though it will earn money for years.

  • Growing too fast

    More orders mean more materials and staff to pay for before the customers pay.

The Parts of a Cash-Flow Forecast

  • Cash inflows

    Money coming into the business: cash sales, payments from customers, loans, and money invested by the owner.

  • Cash outflows

    Money going out of the business: stock, wages, rent, bills and loan repayments.

  • Net cash flow

    Cash inflows - cash outflows. Negative if more goes out than comes in.

  • Opening balance

    The cash the business has at the start of the month. It is always last month's closing balance.

  • Closing balance

    Opening balance + net cash flow. The cash left at the end of the month.

The Café's Cash-Flow Forecast

  • Cash inflows: sales

    January (£): 5,000. February (£): 6,000. March (£): 7,500

  • Rent

    January (£): 1,500. February (£): 1,500. March (£): 1,500

  • Wages

    January (£): 3,000. February (£): 2,500. March (£): 3,000

  • Stock

    January (£): 2,000. February (£): 1,000. March (£): 1,000

  • Total cash outflows

    January (£): 6,500. February (£): 5,000. March (£): 5,500

  • Net cash flow

    January (£): (1,500). February (£): 1,000. March (£): 2,000

  • Opening balance

    January (£): 2,000. February (£): 500. March (£): 1,500

  • Closing balance

    January (£): 500. February (£): 1,500. March (£): 3,500

Working Through January

Always work in this order.

Using the café's forecast, show how January's closing balance is calculated, and why it becomes February's opening balance.

  1. 1 Total cash outflows £1,500 + £3,000 + £2,000 = £6,500
  2. 2 Net cash flow £5,000 - £6,500 = (£1,500)
  3. 3 Closing balance £2,000 + (£1,500) = £500
  4. 4 Carry it forward January's closing balance of £500 becomes February's opening balance

AnswerJanuary closing balance = £500

Reading the Forecast

What the café's owner can learn from it.

  • A difficult January

    More cash goes out than comes in, and the balance falls to just £500 - dangerously low if a bill is bigger than expected.

  • Recovery

    Net cash flow is positive in February and March, so the balance rises to £3,500.

  • Planning ahead

    Knowing January will be tight, the owner could arrange an overdraft in advance, delay buying stock, or run a promotion to boost sales.

  • A forecast, not a fact

    The figures are predictions; if sales are lower than forecast, the cash could run out.

Why Businesses Use Cash-Flow Forecasts

A forecast is an early warning system.

  • Spot shortages early

    See months ahead when cash may run low, and arrange finance before it is needed.

  • Plan spending

    Choose the best time to buy equipment or stock.

  • Get a loan

    Banks usually ask for a cash-flow forecast before lending to a new business.

  • Compare and control

    Compare actual cash flow with the forecast and act if they differ.

Case study

Carillion: Profitable on Paper, Out of Cash

Carillion was one of Britain's biggest construction and services companies, building hospitals and roads and employing around 43,000 people. It reported a profit for 2016, but it was waiting months to be paid on many of its contracts while still having to pay its staff and suppliers, and it had built up huge debts. When it could no longer find the cash to pay what it owed, it went into liquidation in January 2018. Carillion showed that profit on paper is not the same as cash in the bank.

2016 Carillion reports a profit
2018 Carillion goes into liquidation

Complete the Forecast

A bike repair shop starts April with £800. April inflows are £3,000 and outflows £3,600. May inflows are £4,200 and outflows £3,400. June inflows are £2,500 and outflows £3,900. Draw a cash-flow forecast, calculate the net cash flow and closing balance for each month, and say which month the owner should worry about.

1. Draw the table with three month columns.

2. Calculate net cash flow each month.

3. Calculate the closing balance and carry it forward.

4. Name the problem month and suggest one solution.

A good answer shows: Net cash flows of (£600), £800 and (£1,400); closing balances of £200, £1,000 and (£400). June needs action because the balance goes negative.

Can I...?

  1. 1Explain why cash matters to a business.
  2. 2Explain the difference between cash and profit.
  3. 3Explain how a profitable business can run out of cash.
  4. 4Explain cash inflows and outflows.
  5. 5Calculate net cash flow.
  6. 6Calculate opening and closing balances.
  7. 7Interpret a cash-flow forecast.

Summary & Exam Focus

  • Cash is needed to pay suppliers, overheads and employees, and to avoid insolvency.
  • Cash is money available now; profit is revenue minus costs over a period.
  • Net cash flow = inflows - outflows; closing balance = opening balance + net cash flow.
  • A cash-flow forecast warns of shortages so the business can act in time.

Exam focus

Explain one reason why a business might be profitable but still run out of cash. (3 marks) (3 marks)

Use the difference in timing: the sale, and the profit, are counted when the goods are sold, but the cash only arrives when the customer pays.

Key terms

The vocabulary this lesson expects you to use. Each one is linked from the first place it appears above.

Cash
Money a business has available to spend immediately, in the bank or in the till.
Cash flow
The movement of cash into and out of a business.
Cash inflows
Money coming into a business, such as cash sales and loans.
Cash outflows
Money going out of a business, such as wages, rent and stock.
Net cash flow
Cash inflows minus cash outflows.
Opening balance
The cash a business has at the start of a period - last period's closing balance.
Closing balance
Opening balance plus net cash flow.
Insolvency
When a business cannot pay its debts when they are due.
Cash-flow forecast
A prediction of a business's cash inflows and outflows over future months.

Questions and answers

9 questions set on this lesson, with the mark schemes and model answers open.

1. Exam question Define 1 mark Foundation

Define the term 'net cash flow'.

Mark scheme — 1 mark available

  • Cash inflows minus cash outflows — 1 mark

Model answer

The difference between a business's cash inflows and its cash outflows over a period.

2. Exam question State 1 mark Foundation

State one cash outflow for a small business.

Mark scheme — 1 mark available

  • Any valid outflow, e.g. wages; rent; stock / raw materials; utility bills; loan repayments — 1 mark

Model answer

Wages.

3. Exam question Calculate 2 marks Foundation

A business has an opening balance of £1,200. In March its cash inflows are £4,500 and its cash outflows are £5,100. Calculate its closing balance for March. You are advised to show your working.

Mark scheme — 2 marks available

  • Correct method: opening balance + (inflows - outflows) — 1 mark
  • Correct answer: £600 — 1 mark (award 2 marks for the correct answer with no working)

Model answer

Net cash flow = £4,500 - £5,100 = (£600). Closing balance = £1,200 + (£600) = £600

4. Exam question Outline 2 marks Foundation

Outline one benefit to a small business of producing a cash-flow forecast.

Mark scheme — 2 marks available

  • A benefit identified, e.g. predicts shortages / helps get a loan / helps plan spending — 1 mark
  • Developed: how this helps the business — 1 mark

Model answer

It can show in advance when the business might run short of cash (1), so the owner can arrange an overdraft before the shortage happens (1).

5. Exam question Explain 3 marks Foundation

Explain one reason why a business might be profitable but still run out of cash.

Mark scheme — 3 marks available

  • A reason identified, e.g. customers paying late / buying stock in advance / large purchases — 1 mark
  • First linked point of explanation — 1 mark
  • Second linked point of explanation — 1 mark

Model answer

Its customers may pay on credit (1). The sale counts towards profit when it is made, but the cash does not arrive until the customer pays, perhaps 60 days later (1). Meanwhile the business must still pay its suppliers and staff, so it can run out of cash even though it is making a profit (1).

6. Multiple choice 1 mark Foundation

How is the closing balance calculated?

  1. A Cash inflows - cash outflows
  2. B Opening balance + net cash flow Correct
  3. C Revenue - total costs
  4. D Opening balance - cash inflows

Why: Closing balance = opening balance + net cash flow.

7. Multiple choice 1 mark Core

A business's March closing balance is £2,300. What is its April opening balance?

  1. A £2,300 Correct
  2. B £0
  3. C It depends on April's sales
  4. D £4,600

Why: Each month's opening balance is the previous month's closing balance.

8. Multiple choice 1 mark Core

A business has inflows of £8,000 and outflows of £9,500. What is its net cash flow?

  1. A £1,500
  2. B £17,500
  3. C (£17,500)
  4. D (£1,500) Correct

Why: £8,000 - £9,500 = (£1,500), a negative net cash flow.

9. Multiple choice 1 mark Stretch

What does insolvency mean?

  1. A The business has made a loss this year
  2. B The business has no competitors
  3. C The business cannot pay its debts when they are due Correct
  4. D The business has more cash than it needs

Why: A business is insolvent when it cannot pay its debts when they are due - often because it has run out of cash.