Cash flow introduction

Cash flow introduction

ZIMSEC O Level Business Studies Notes: Business Finance and Accounting: 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

Differences between profit and cash flow

  • 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 theĀ O Level Business Notes

By |2017-06-29T10:44:00+00:00June 29th, 2017|Notes, O Level Business Studies Notes, Ordinary Level Notes|Comments Off on Cash flow introduction

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He holds an Honours in Accountancy degree from the University of Zimbabwe. He is passionate about technology and its practical application in today's world.
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