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Cash-Flow
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Teaching Business
Cash Flow
A complete guide to cash flow and cash flow forecasting — covering cash inflows, cash outflows, net cash flow, opening and closing balances, and how businesses use forecasts to manage liquidity.
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Created by an experienced Head of Business and examiner
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KEY POINTS
Cash flow is the movement of money into and out of a business over a period of time.
Cash inflows are money received by the business, such as sales revenue, loans or owner investment.
Cash outflows are money leaving the business, such as wages, rent, stock, bills and loan repayments.
Net cash flow is calculated by subtracting total cash outflows from total cash inflows.
The closing balance shows how much cash the business has available at the end of a period.
A cash flow forecast helps a business predict future cash shortages or surpluses.
A profitable business can still experience cash flow problems if money is not received quickly enough.
Cash flow forecasting helps managers plan ahead, arrange finance and make better financial decisions.
KEY DEFINITION
Cash Flow
A measure of the inflows and outflows of cash through a business over a specific period of time.
Main Explanation
Cash flow refers to the movement of money into and out of a business over a period of time. Cash inflows are the money received by the business, such as revenue from sales, loans, owner investment or payments from customers. Cash outflows are the money leaving the business, such as payments for wages, rent, stock, raw materials, loan repayments and bills.
Cash flow is important because a business needs enough cash available to pay its day-to-day expenses. A business can be profitable on paper but still experience cash flow problems if money is not received quickly enough. For example, a business may make sales on credit but still struggle to pay suppliers if customers take a long time to pay.
Cash flow forecasting involves predicting future cash inflows and outflows. This helps a business identify periods when it may have a cash shortage or cash surplus. Managers can then make better decisions, such as arranging an overdraft, delaying spending, chasing late payments, reducing costs or planning investment.
Positive cash flow means more cash is coming into the business than leaving it during a period. Negative cash flow means cash outflows are greater than cash inflows. A negative cash flow position is not always a problem if it is temporary and planned, but persistent negative cash flow can threaten the survival of the business.
✎ EXAMINER TIP
It is very easy to confuse cash flow with profit. Always remember that cash flow focuses on the timing of money entering and leaving the business, while profit compares revenue with costs. When calculating a closing balance, first calculate net cash flow and then add it to the opening balance.
KEY FORMULAS(s)
Profit and Profitability Formulas
These key formulas help you calculate different profit measures and profitability ratios used in business.
Gross Profit
Gross profit = Revenue − Cost of sales
The profit made after deducting direct costs.
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Remember: profit shows how much money has been made, while profitability shows how efficiently revenue is being turned into profit.
DATA TABLE
Income Statement for North Coast Coffee Ltd
This statement shows how revenue is converted into gross profit, operating profit and net profit.
Revenue
£250,000
Output
Fixed Costs
Variable Costs
Total Costs
Revenue
Profit / Loss
0 candles £1,200 £0 £1,200 £0 -£1,200
Net profit is the final profit remaining after all costs and expenses have been deducted from revenue.
WORKED EXAMPLE
Worked Example: North Coast Coffee
How many coffees must be sold to break even?
Fixed Costs
£1,800
equity + long-term debt
Break-even output = Fixed costs ÷ Contribution per unit
Contribution per unit = Selling price − Variable cost
£3.50 − £1.10 = £2.40
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Step 1: Calculate contribution
£3.50 − £1.10 = £2.40
Contribution per unit is the amount each coffee contributes towards fixed costs.
BREAK-EVEN OUTPUT:
750 coffees per month
EXAM TIP
Always explain what the number means for the business. Do not just calculate the break-even point.
Typical Cash Flow Cycle
It is essential if a business is to continue trading that they carefully manage their cash inflows and outflows to avoid liquidity problems. A business can continue trading if they make a financial loss but running out of cash is far more serious.
APPLICATION
Tesco
Tesco is one of the UK’s largest supermarket retailers, selling groceries and other products through stores and online delivery. The business receives regular cash inflows from customer sales, but it also has major cash outflows such as wages, supplier payments, rent, energy costs and delivery costs.
Cash flow forecasting helps Tesco plan whether it will have enough cash available to cover these payments. For example, before Christmas, Tesco may need to spend more on stock, staffing and distribution before all of the extra sales revenue is received. A cash flow forecast would help managers predict these inflows and outflows in advance.
This makes cash flow forecasting useful because it helps Tesco manage liquidity, plan spending and make sure the business can continue operating smoothly.
This independent educational case study is not affiliated with, endorsed by or sponsored by Greggs plc. Any financial figures used alongside this example should be treated as simplified or hypothetical estimates created for teaching purposes.
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ANALYSIS
EXAM FOCUS
Analysis questions require you to examine a business concept or issue in detail, breaking it down into its component parts. You should explain how and why something happens and consider its impact on the business.
How to Approach Analysis Questions
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Identify the key issue or concept
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Break it down
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Explain how and why
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Reach a reasoned conclusion
Read the question carefully and highlight the focus of the analysis.
Consider the different factors, causes or impacts related to the issue.
Provide clear explanations using business terms and links points to context.
Evaluate the overall implications for the business.
Example Analysis Question
North Coast Coffee is considering using break-even analysis before opening a second café.
Advantages
• Sales forecasts may be inaccurate.
• Assumes costs and revenue remain constant.
• External factors may reduce reliability.
• Ignores qualitative business factors.
Disadvantages
• Sales forecasts may be inaccurate.
• Assumes costs and revenue remain constant.
• External factors may reduce reliability.
• Ignores qualitative business factors.
Key Exam Tip
If you find it difficult to expand your answer and show the type of depth that an examiner is looking for in a top response, consider using the 'so what' approach.
Tesco carry out market research - so what? - this allows them to better understand customer needs - so what? as a result Tesco can provide goods more likely to sell - so what? - this will increase Tesco profit and ensure higher levels of customer satisfaction - so what? this means that customers are likely to become more loyal to Tesco.
Avoid These Exam Traps
Students often lose marks on calculation and analysis questions by making these mistakes. Watch out for them in your exam!
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Helvetica Light is an easy-to-read font, with tall and narrow letters, that works well on almost every site.
Tip:
Helvetica Light is an easy-to-read font, with tall and narrow letters, that works well on almost every site.
2
Helvetica Light is an easy-to-read font, with tall and narrow letters, that works well on almost every site.
Helvetica Light is an easy-to-read font, with tall and narrow letters, that works well on almost every site.
Tip:
Helvetica Light is an easy-to-read font, with tall and narrow letters, that works well on almost every site.
3
Helvetica Light is an easy-to-read font, with tall and narrow letters, that works well on almost every site.
Helvetica Light is an easy-to-read font, with tall and narrow letters, that works well on almost every site.
Tip:
Helvetica Light is an easy-to-read font, with tall and narrow letters, that works well on almost every site.
Be precise. Read the question carefully. Show your working.
Small mistakes can cost big marks.
EXAM PRACTICE
Practice Question
Apply your knowledge of profit and profitability to answer this exam-style question.
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MINI CASE STUDY
North Coast Coffee Ltd is a premium coffee business which sells freshly roasted coffee beans through its online store and a small chain of independent cafés. The business has experienced strong sales growth due to increasing demand for high-quality speciality coffee products.
The business generates annual revenue of £250,000. Its cost of sales, including coffee beans, packaging and direct production costs, totals £100,000. North Coast Coffee Ltd also faces operating expenses of £80,000, including marketing, employee wages, rent and administration costs. In addition, the business pays £20,000 in interest and taxation each year.
The owner, Mia Thompson, is reviewing the company’s profitability because rising wage costs and increased competition in the premium coffee market have started to place pressure on operating profit margins. She is considering increasing prices slightly in order to protect profitability while still maintaining customer demand.
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EXAM QUESTION
Analyse the possible reasons for BrightBite’s falling profit margins and evaluate strategies it could use to improve profitability.
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HOW TO ANSWER
P
Point
E
Explain
A
Apply
C
Consequence
H
However...
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MODEL ANSWER
P
Point
Increasing prices could improve the profitability of North Coast Coffee Ltd because each sale would generate a larger amount of revenue and potentially increase profit margins.
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EXAMINER TIP
For full marks, make sure you analyse causes rather than just listing them, and evaluate realistic strategies with clear judgement. THINK: Which strategy would have the biggest impact and why?
CALCULATOR
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