Cash flow introduction

Cash flow is defined as the movement of cash into and out of the business
Cash flowing into the business is called cash inflow
Conversely cash flowing out is called cash out flow
In accounting terms cash flow is viewed as the difference between the amount of cash at the end of the year versus the amount of cash we had at the beginning
If the amount of cash outflows exceed the amount of inflows in a given period this is known as negative cash flow or deficit
On the other hand if the amount of cash inflows exceed the amount of outflows in a given period this is known as positive cashflow or surplus
In finance and accounting terms cash is defined as ready money
includes money in hand, petty cash, bank account balance, customer checks, and marketable securities
The later are known as cash equivalent
Cash is the primary means by which a business meets it’s financial obligations
A business that has ample surplus cash flow is said to be liquid
A business that has a deficit is said to be illiquid

Profit is the difference between revenue obtained from operations and the expenses incurred in generating that revenue
Cash flow meanwhile is the net difference between cash inflows and cash outflows in a given period
Profit is shown in the Income statement/Statement of comprehensive income which was formerly known as the Trading and Profit and Loss Account
On the other hand Cash Flow is shown in the Cash Flow statement
Profit is calculated using what is known as the matching concept or the accrual basis while cash flows are calculated on a cash basis
Consider the following example:
John starts his business with $5000 which he uses to purchase goods worth $4 000 and sells for $5 000 on credit
Assuming no other transactions take place in John’s business
His profit will be $5 000 – $ 4 000 = $1 000
His cash flow would be: $5 000-$ 4 000= $1 000
It must be noted that the above is a very simple case
Consider a more nuanced example where John starts with $5 000, makes purchases worth $5 000, sells the goods for $7 000 credit and receives $500 in cash from his debtors
His profit would be $7 000-$5 000 = $2 000
His cash flow would be $5 000 (start up amount) – $5 000 (expended towards purchases)+ $200 (received from creditors)= $500
As you can see the figures are clearly different
It is therefore possible for a business to be profitable but still have liquidity problems

NB Click here to learn more about the importance of cash flow to a business

To access more topics go to the O Level Business Notes

Cash flow introduction- Updated 2024