3.7 Cash flow Flashcards
what is the difference between cash and profit?
cash is a current asset - the money that a business actually receives from the sale of goods and services
profit is the positive difference between a firm’s total sales revenue and total costs of production
How is it possible for a firm to be profitable but cash deficient?
When making a purchase, customers might have several payment options, e.g. cash, cheque or credit. Paying by credit
means that customers can buy now but pay later. This might attract customers but can also cause cash flow problems for the business
since it will need to operate without immediate payment from its credit customers.
How to calculate Profit?
Profit = Revenues - Costs
What is ‘working capital’?
Working capital refers to the cash or liquid assets available for the daily running of a business.
What can insufficient working capital lead to?
Inadequate working capital leads to insolvency (a situation where working
capital is insufficient to meet current liabilities). This can lead to the collapse of the business as creditors will take legal action to recover their money. This causes liquidation of the firm, i.e.
it will need to sell off its assets to repay as much of the money owed to its creditors.
How is ‘working capital’ calculated?
Working Capital = Current assets - Current liabilities
What are ‘current assets’? What are the three types of current assets?
Current assets are the liquid resources belonging to a business that are expected to be converted to cash within the next twelve
months.
- debtors, cash, stock
What are ‘current liabilities? What are the three types of current liabilities?
the money that a business owes that needs to be repaid within the next twelve months.
- overdrafts, creditors, tax
What is the ‘working capital cycle’?
The interval between cash payments for costs of
production and cash receipts from customers
What is a ‘cash flow forecast’?
cash flow forecast is a financial document that shows the expected movement of cash into and out of a business, per time
period.
What are the three concepts on which it is based on?
cash inflows
cash outflows
net cash flow
What are the reasons for a cash flow forecast?
- Banks and other lenders require a cash flow forecast to help them assess the financial health of the business seeking external finance.
- Help managers to anticipate and identify periods of potential liquidity problems
- Aid business planning
What is the ‘opening’ and ‘closing’ balance? How are they linked?
Opening balance is the amount of cash at the beginning of a trading period.
Closing balance is the amount of cash at the end of a trading period.
Closing balance = Opening balance plus Net cash flow
What are the five causes of cash flow problems?
overtrading over-borrowing overstocking poor credit control unforeseen changes
What is the relationship between investment, profit and cash flow?
When a business sells an investment, it experiences an increase in its cash flow position. The opposite happens when a business buys an investment.
When a firm obtains finance for investments, the cash inflow improves its liquidity position.
