Understanding Cash Flow (and why profitable businesses still go bust)
Cash flow is the movement of cash into and out of a firm’s bank account.
Profit is when revenue is greater than total costs.
Those two sentences look similar… right up until your “profitable” business can’t pay the rent on Friday.
Think of it like this:
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Profit is your score (based on what you’ve earned and what you’ve incurred).
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Cash flow is your oxygen (based on what has actually arrived in the bank, and what’s actually left it).
A business can “win on points” (profit) while still running out of oxygen (cash).
Why cash flow and profit don’t match
1) Timing: “Sold” doesn’t mean “paid”
You might invoice a customer today… but they might pay in 30, 60, or 90 days.
So your accounts may show a profitable sale, but your bank account is still doing its best impression of a tumbleweed.
Example:
You sell £10,000 worth of work in January on 60-day terms.
That’s great for profit in January… but the cash might not show up until March.
2) Cash leaves before you’ve “made” the sale
Businesses often pay for stock, wages, and rent before customers pay them.
That gap is where cash flow dramas live.
3) Non-cash costs affect profit (but not cash)
Some costs reduce profit without an immediate cash payment.
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Depreciation is the classic: the value of equipment “wearing out” on paper.
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The cash left the bank when you bought the kit, not each month afterwards.
So you can have:
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Lower profit due to depreciation,
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while cash flow that month looks fine.
4) Investment spending hurts cash flow (but not necessarily profit)
Buying a new van, refurbishing the shop, purchasing a 3D printer that you absolutely “need” (honestly)…
That’s a cash outflow now, even though the benefit is spread over years.
5) Loan repayments are cash outflows, but not all are “costs”
Repaying a loan:
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Interest counts as a cost (affects profit),
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Repaying the capital does not count as a cost, but it does reduce cash.
This catches students out all the time.
A simple cash flow example (the “how are we broke?” moment)
Imagine a small business in January:
Cash in:
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Customers pay: £2,000
Cash out:
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Rent: £1,200
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Wages: £1,500
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Stock purchase: £800
Net cash flow = £2,000 − (£1,200 + £1,500 + £800)
Net cash flow = £2,000 − £3,500 = –£1,500
So cash is falling.
But profit for January might look like this:
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Sales made (invoiced): £6,000
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Costs incurred: £4,000
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Profit = £2,000
Profit: +£2,000
Cash flow: –£1,500
That’s how you can be profitable and panicking in the same month.
Why cash flow matters so much in Business Studies (and real life)
Cash flow problems can cause:
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Late payments to suppliers (and damaged relationships)
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Missed wages (and an instant morale collapse)
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Emergency overdrafts (and extra costs)
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In extreme cases: business failure, even when the business is “profitable”
In exams, you’ll often link this to:
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Working capital (current assets − current liabilities)
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Cash flow forecasting
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Reasons for using finance (overdrafts, short-term loans)
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Managing trade credit (both given and received)
Quick ways businesses improve cash flow
Increase cash inflows
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Encourage faster customer payments (shorter credit terms)
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Offer small discounts for early payment
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Chase late invoices (politely at first… then less politely)
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Take deposits or upfront payments
Reduce or delay cash outflows
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Negotiate longer payment terms with suppliers
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Reduce unnecessary spending
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Manage stock levels (too much stock = cash sitting on shelves)
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Lease rather than buy expensive assets (sometimes)
Mini “exam-ready” summary
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Profit = revenue − total costs (measured over a period, includes non-cash items).
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Cash flow = actual cash in − actual cash out (bank balance reality).
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A business can be profitable but still fail if it can’t meet short-term payments.
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