Cash-flow forecasting and working capital
Cash is not profit
- Cash is the money you can use right now; profit is revenue minus costs over a period.
- A business can be profitable yet run out of cash (e.g. customers haven't paid) — which can force it to close.
Practice
A business can be making a profit but still run out of cash.
Profit and cash differ — e.g. if customers have not yet paid, a profitable firm may lack cash.
Cash-flow forecast
$$\text{net cash flow} = \text{inflows} - \text{outflows}$$
$$\text{closing balance} = \text{opening balance} + \text{net cash flow}$$
- A forecast warns of a shortage early.
Practice
Inflows are 20,000 and outflows are 14,000. What is the net cash flow (in dollars)?
Net cash flow = inflows − outflows = 20,000 − 14,000 = 6,000.
Working capital
$$\text{working capital} = \text{current assets} - \text{current liabilities}$$
- Fix cash-flow problems: arrange an overdraft, delay paying suppliers, ask customers to pay sooner, sell spare assets, or cut spending.
Practice
Current assets are 40,000 and current liabilities are 25,000. What is the working capital (in dollars)?
Working capital = current assets − current liabilities = 40,000 − 25,000 = 15,000.
You've got it
Key idea
- cash ≠ profit — a profitable firm can still run out of cash
- net cash flow = inflows − outflows; closing = opening + net cash flow
- working capital = current assets − current liabilities