The Importance of Cash (Edexcel IGCSE Business): Revision Note

The purpose of cash

• Cash is the 'lifeblood' of a business as without it a business will likely become insolvent relatively quickly

  • It is the most liquid form of current asset in the form of notes and coins on a businesses premises as well as money deposited in the bank

• Cash performs a variety of functions in a business

  • It is used to cover regular operating expenses such as workers' pay, supplier invoices and overheads such as rent and utility bills

  • It can also be used to meet unexpected expenses such as the replacement of broken equipment

• A new business may have to pay cash on purchase for all of its supplies until its suppliers trust them enough to provide trade credit

  • A supplier may then give the business 30 or 60 days to pay what they owe

    • Stock is received from a supplier

    • The business sells its products and receives cash in the form of sales revenue

    • At the end of the credit period, the supplier is paid

Comparing cash and profit

• Profit and cash are different financial terminologies

  • Profit is calculated at a specific point in time

  • While a business may ultimately make a profit, they may lack cash at times because some customers may not actually have paid them yet

• Profit is the difference between revenue generated and total business costs during a specific period of time

  • Profit can be an important indicator of a company's financial health and long-term sustainability as it helps to assess the effectiveness of a company's operations

• Cash is measured by taking into account the full range of money flowing in and out of a business

  • This includes revenue from sales, operating expenses, investments, loans, and any other cash-related transactions

• Cash-poor businesses will struggle to pay suppliers, meet rent payments or struggle to pay workers

  • A profitable business is likely to fail if it does not have sufficient cash

    • E.g. Lifestyle retailer Joules announced plans to liquidate in December 2022 as a result of cash-flow difficulties, despite making a profit of £2.6 million during the previous year

Cash inflows and outflows

• Cash inflows are sums of money introduced to the business

  • Examples include money earned from sales, monies received such as loans or owners' capital and interest from investments

Calculation of net cash flow

• Cash outflows are sums of money leaving the business

  • Examples include payments to suppliers, wages and salaries, loan repayments and advertising expenses

• The difference between cash inflows and cash outflows during a period of time is known as the net cash flow