Cash flow – the movement of money in and out of a business
A company can be profitable and have negative cash flow and vice versa. If a company is selling a profitable product but if suppliers want payment within 15 to 30 days whereas wholesale buyers only pay invoices around 120 days. This means they have a lack of available cash. This is an issue with timing which is one of the differences between cash flow and profit. The other difference is the way fixed assets are accounted for. Fixed assets are treated as capital expenditure in the financial statements – that means that the cost of those assets is not treated as an operating cost (do not affect profits). They are still a cash outflow but if there is a depreciation in the value of these fixed assets, it is treated as a cost and affects profits
Cash flow is very important to a business as liquid cash is required to for payment such as wages, bills and raw materials. A business must be able to generate adequate cash to cover their costs.
Forecasting and interpreting cash flow
A cash flow forecast can predict future cash flow over a period of time. It estimates when cash will leave and enter the bank account. It helps estimate the net balance at the end of each period of time e.g. month.
Use of a cash-flow forecast to identify credit requirements and minimise risk
A cash flow forecast can be used to identify where the majority of business spending goes to and whether they are spending more than they can afford. If a company predicts it will have sufficient cash left at the end of the month to cover costs and also can ensure whether there is sufficient overdraft facility. It also helps outline whether the firm’s operations are generating cash and whether objectives are being achieved.
It will also mean that firms can anticipate when there are higher costs and take the necessary precautions (e.g. loans) to cover any cash shortfalls. It ensures that money coming in from buyers is enough to cover the fees paid to suppliers.