Importance of Cash in Business Finance

Importance of Cash

• Cash is essential for businesses to pay suppliers, employees, rent, and other operational costs.
• Insufficient cash can lead to business failure (insolvency), impacting debt repayment.
• Cash is foundational for investment, expansion, and handling unexpected issues.

Cash vs. Profit

• Cash represents readily available funds for a business.
• Profit is the remaining amount after expenses are deducted.
• Cash availability differs from post-expense earnings.

Cash Flow

• Cash flow tracks money movement into and out of a business.
• Positive cash flow signifies healthy operations (inflows exceed outflows).
• Negative cash flow potentially indicates financial trouble (outflows exceed inflows).

Cash Inflows

• Customer payments are a primary cash inflow.
• Bank loans are a source of cash.
• Bank interest received increases available cash.
• Sales of fixed assets contribute to cash inflow.
• Supplier refunds add to positive cash flow.
• Business owner loans enhance cash resources.
• Grants and funding proceeds boost available capital.

Cash Outflows

• Supplier payments are a significant cash outflow.
• Bank loan repayments reduce cash reserves.
• Bank charges decrease available funds.
• Purchasing fixed assets reduces cash.
• Dividends paid decrease available capital.
• Salaries and wages are substantial cash outflows.
• Car payments are a regular cash outflow.
• Insurance premiums are a recurring cash outflow.
• Tax payments reduce available cash.

Net Cash Flow

• Net cash flow is the difference between total inflows and outflows.
• Formula: Cash receipts minus cash payments.
• Net cash flow types:
  • Operating activities: Daily business cash flows.
  • Financing activities: Cash from or used for debt.
  • Investing activities: Cash from or used for investments.

Opening and Closing Balances

• Opening balance is the initial amount at a period's start.
• Closing balance reflects the amount at a period's end.

Cash Flow Forecast

• A cash flow forecast predicts future cash inflows and outflows.
• Typically covers a 12-month period; shorter intervals are suitable for smaller businesses.
• Forecasts should be regularly updated with the changing circumstances.

Purpose of Cash Flow Forecast

• Assists in planning and identifies potential cash shortfalls.
• Aids in managing significant expenditures.
• Helps with sales planning and pinpoints areas of excessive spending.
• Improves understanding of a business's cash flow patterns.

Example of Cash Flow Forecast

• A six-month forecast demonstrates opening/closing balances, inflows, outflows, and net cash flow per month.
• The prior period's closing balance becomes the subsequent period's opening balance.