EDEXCEL GCSE BUSINESS · PAPER 1
Cash and cash flow forecasting
Putting a business idea into practice · Lesson 4 of 5
Teacher copy - includes the notes for whoever is teaching from it.
Last Lesson
Answer from memory before the answers appear.
1. What is break-even?
The point where total revenue equals total costs.
2. How do you calculate break-even output?
Fixed costs ÷ (sales price - variable cost per unit).
3. What is the margin of safety?
Actual sales - break-even output.
4. What happens to break-even if fixed costs rise?
It rises - more units must be sold.
Learning Objectives
1. Explain the importance of cash to a business.
2. Explain the difference between cash and profit.
3. Explain cash inflows, cash outflows and net cash flow.
4. Calculate opening and closing balances in a cash-flow forecast.
5. Interpret 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.
Watching the Bank Balance
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Small business owners check their cash constantly, because the bills never stop: suppliers, rent, wages. A cash-flow forecast lets them see a problem coming months before it arrives, while there is still time to do something about it. |
Knowing how much cash there is - and will be - is part of the daily job. |
Cash or Profit?
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CASH |
PROFIT |
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▸ 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. |
▸ 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.
PART TWO
Cash-Flow Forecasts
Predicting the cash that will come in and go out, month by month.
The Parts of a Cash-Flow Forecast
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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. |
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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. |
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Closing balance Opening balance + net cash flow. The cash left at the end of the month. |
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The Café's Cash-Flow Forecast
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Item |
January (£) |
February (£) |
March (£) |
|---|---|---|---|
|
Cash inflows: sales |
5,000 |
6,000 |
7,500 |
|
Rent |
1,500 |
1,500 |
1,500 |
|
Wages |
3,000 |
2,500 |
3,000 |
|
Stock |
2,000 |
1,000 |
1,000 |
|
Total cash outflows |
6,500 |
5,000 |
5,500 |
|
Net cash flow |
(1,500) |
1,000 |
2,000 |
|
Opening balance |
2,000 |
500 |
1,500 |
|
Closing balance |
500 |
1,500 |
3,500 |
Working Through January
Always work in this order.
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Using the café's forecast, show how January's closing balance is calculated, and why it becomes February's opening balance. |
1. Total cash outflows
£1,500 + £3,000 + £2,000 = £6,500
2. Net cash flow
£5,000 - £6,500 = (£1,500)
3. Closing balance
£2,000 + (£1,500) = £500
4. Carry it forward
January's closing balance of £500 becomes February's opening balance
Answer: January 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
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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. |
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2016 Carillion reports a profit |
2018 Carillion goes into liquidation |
Key Terms
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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. |
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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. |
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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. |
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Closing balance Opening balance plus net cash flow. |
Insolvency When a business cannot pay its debts when they are due. |
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Cash-flow forecast A prediction of a business's cash inflows and outflows over future months. |
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Your Task: Complete the Forecast
15 minutes
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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.
Note: The common slip is forgetting to carry the closing balance forward. Insist on the opening balance row.
Can I...?
☐ Explain why cash matters to a business.
☐ Explain the difference between cash and profit.
☐ Explain how a profitable business can run out of cash.
☐ Explain cash inflows and outflows.
☐ Calculate net cash flow.
☐ Calculate opening and closing balances.
☐ Interpret a cash-flow forecast.
Summary
✓ 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.
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EXAM FOCUS Explain one reason why a business might be profitable but still run out of cash. (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. |
Exam Practice: Cash and Cash Flow Forecasting
Answer all questions. Show your working in calculations. · 25 minutes
▸ Question 1 · 1 mark · Define. Define the term 'net cash flow'.
▸ Question 2 · 1 mark · State. State one cash outflow for a small business.
▸ Question 3 · 2 marks · Calculate. 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…
▸ Question 4 · 2 marks · Outline. Outline one benefit to a small business of producing a cash-flow forecast.
▸ Question 5 · 3 marks · Explain. Explain one reason why a business might be profitable but still run out of cash.
Question 1 · 1 mark · Define
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“Define the term 'net cash flow'.” |
HOW TO ANSWER IT Command word: Define. Worth 1 mark, so plan before writing.
Question 1 · mark scheme
1 mark available. Award a mark for each point made.
▸ Cash inflows minus cash outflows. 1 mark
▸ Model answer. The difference between a business's cash inflows and its cash outflows over a period.
Question 2 · 1 mark · State
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“State one cash outflow for a small business.” |
HOW TO ANSWER IT Command word: State. Worth 1 mark, so plan before writing.
Question 2 · mark scheme
1 mark available. Award a mark for each point made.
▸ Any valid outflow, e.g. wages; rent; stock / raw materials; utility bills; loan repayments. 1 mark
▸ Model answer. Wages.
Question 3 · 2 marks · Calculate
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“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.” |
HOW TO ANSWER IT Command word: Calculate. Worth 2 marks, so plan before writing.
Question 3 · mark scheme
2 marks available. Award a mark for each point made.
▸ 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
Question 4 · 2 marks · Outline
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“Outline one benefit to a small business of producing a cash-flow forecast.” |
HOW TO ANSWER IT Command word: Outline. Worth 2 marks, so plan before writing.
Question 4 · mark scheme
2 marks available. Award a mark for each point made.
▸ 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).
Question 5 · 3 marks · Explain
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“Explain one reason why a business might be profitable but still run out of cash.” |
HOW TO ANSWER IT Command word: Explain. Worth 3 marks, so plan before writing.
Question 5 · mark scheme
3 marks available. Award a mark for each point made.
▸ 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).