Business Studies – 5.2.1 The importance of cash and cash flow forecasts | e-Consult

Cash flow refers to the movement of actual cash into and out of a business over a period. It's about the timing of receipts and payments. Profit, on the other hand, is the difference between a business's total revenue and its total expenses over a period. Profit is calculated using accrual accounting, which recognizes revenue when earned and expenses when incurred, regardless of when cash changes hands.

It's important to monitor both cash flow and profit because:

• Profitability doesn't guarantee liquidity: A business can be profitable on paper but still face cash flow problems. For example, a business might have high sales but if customers take a long time to pay, or if the business has large upfront costs, it could struggle to meet its short-term obligations.
• Cash flow is essential for day-to-day operations: A business needs sufficient cash to pay its bills, salaries, and other expenses. Even if a business is profitable, poor cash flow can lead to difficulties in meeting these obligations and potentially even insolvency.
• Identifying potential problems early: Monitoring both metrics together provides a more comprehensive view of the business's financial health. A declining cash flow despite a healthy profit could signal problems with collecting payments or managing expenses.