Cash flow forecasts
AQA also says:
Spec content: Importance of cash to businesses; Interpreting cash flow forecasts; Difference between cash and profit.
Students should be able to: understand the consequences of cash flow problems and the effect of positive cash flow; understand how and why cash flow forecasts are constructed; complete and interpret sections of a cash flow forecast (cash inflows, outflows, net cash flow, opening and closing balance). Students are NOT expected to construct an entire cash flow forecast from scratch.
Why Cash Flow Matters
A business can be profitable on paper but still fail if it runs out of cash. Cash flow is the movement of money into and out of a business over a period of time. A business needs cash to pay its employees, suppliers, rent, and loan repayments — all of which must be paid in cash regardless of whether the business has made a profit.
The difference between cash and profit is critical:
- Profit is revenue minus costs, calculated over an accounting period — it is an accounting concept.
- Cash is money physically available in the bank — it is a practical reality. Profit does not equal cash because customers may owe money (debtors), the business may have bought stock not yet sold, or depreciation reduces profit without consuming cash.
A business experiencing cash flow problems — where outflows exceed inflows — faces the risk of being unable to pay its obligations even if it is ultimately profitable. Suppliers may refuse to deliver; staff may not be paid; loans may default. In the worst case, an otherwise viable business can be forced to cease trading through lack of cash alone.
The Cash Flow Forecast
A cash flow forecast is a month-by-month projection of the cash a business expects to receive and pay out, and the resulting cash balance. It allows management to anticipate cash shortfalls in advance and take action before a crisis occurs.
Key Components
- Cash inflows — all money expected to come into the business: sales revenue, loans received, asset sales, capital injections from owners.
- Cash outflows — all money expected to leave the business: purchases, wages, rent, utilities, loan repayments, tax, marketing costs.
- Net cash flow = Cash inflows − Cash outflows for the period.
- Opening balance — the cash balance at the start of the period (= closing balance of the previous period).
- Closing balance = Opening balance + Net cash flow.
Worked Example
| January (£) | February (£) | March (£) | |
|---|---|---|---|
| Total cash inflows | 8,500 | 9,200 | 7,800 |
| Total cash outflows | 7,800 | 10,400 | 8,100 |
| Net cash flow | +700 | -1,200 | -300 |
| Opening balance | 1,500 | 2,200 | 1,000 |
| Closing balance | 2,200 | 1,000 | 700 |
The February closing balance of £1,000 becomes the March opening balance. By March, the closing balance has fallen to £700 — still positive, but declining. If this trend continues, the business will face a negative closing balance (overdrawn position) in subsequent months, signalling an urgent need for action.
Benefits of Cash Flow Forecasting
- Identifies potential cash shortfalls in advance — giving time to arrange an overdraft, delay a purchase, or accelerate a sale before the crisis hits
- Required by banks and investors when assessing a business's viability
- Helps plan the timing of major expenditures to avoid simultaneous cash outflows
- Provides a benchmark against which actual cash flow can be compared
Key Takeaways
- Cash ≠ profit — a profitable business can fail if it runs out of cash.
- Net cash flow = Cash inflows − Cash outflows
- Closing balance = Opening balance + Net cash flow
- The opening balance of each period equals the closing balance of the previous period.
- Cash flow forecasts identify problems before they become crises — early warning enables early action.