Business finance and cash flow
Businesses need finance to start, grow and run day to day. They choose suitable sources of finance and use cash-flow forecasts to avoid running out of cash.
📌 Key points
- Businesses need finance for start-up capital, capital expenditure (long-term assets such as buildings and machinery) and revenue expenditure (day-to-day costs such as wages and rent).
- Internal sources: retained profit, sale of existing assets and the owner’s own savings (for sole traders and partnerships).
- External sources: issuing shares (limited companies only), bank loans, overdrafts, trade credit, leasing, hire purchase, microfinance and crowdfunding.
- Short-term finance (overdraft, trade credit) pays for day-to-day needs; long-term finance (loans, shares) pays for long-term assets.
- The choice of finance depends on the purpose, the amount needed, the legal form and size of the business, the cost, and whether the owners will accept loss of control.
- Cash flow is the movement of cash into and out of a business; a profitable business can still fail if it runs out of cash.
- In a cash-flow forecast: net cash flow = cash inflows − cash outflows; closing balance = opening balance + net cash flow; each closing balance is the next month’s opening balance.
- A cash-flow forecast helps plan, shows when an overdraft is needed and supports a loan application.
- Cash-flow problems can be solved by an overdraft, asking customers to pay sooner, delaying payments to suppliers or delaying buying new assets.
- Working capital = current assets − current liabilities; it is the money available to pay day-to-day expenses.
📖 Key terms
- Capital expenditure
- Money spent on non-current assets that last for more than a year.
- Revenue expenditure
- Money spent on day-to-day expenses, e.g. wages and rent.
- Retained profit
- Profit kept in the business after tax and dividends are paid.
- Overdraft
- Permission from the bank to spend more than is in the account, up to a set limit.
- Trade credit
- When suppliers deliver goods now but allow payment later.
- Cash-flow forecast
- An estimate of future cash inflows and outflows, usually month by month.
- Working capital
- Current assets minus current liabilities.
- Crowdfunding
- Raising capital from a large number of people who each invest a small amount, usually online.
✏️ Worked example
A shop’s opening cash balance for March is $2,000. Cash inflows in March are $8,500 and cash outflows are $10,000. Calculate the net cash flow and the closing balance, and the opening balance for April.
- Net cash flow = inflows − outflows = $8,500 − $10,000 = −$1,500.
- Closing balance = opening balance + net cash flow.
- = $2,000 + (−$1,500) = $500.
- April’s opening balance is March’s closing balance.
- Answer: net cash flow −$1,500; closing balance $500; April opening balance $500.
Cash is not profit. A firm can be profitable on paper but run out of cash if customers pay late or it spends heavily on new assets.
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