• PROFIT is the positive difference between a firm's total sales revenue and its total costs of production for a given time period. 

PROFIT = TOTAL REVENUE - TOTAL COST

• "Profit seems a simple concept, if you make profit it means your cash inflow is greater than you cash outflow, so you have surplus of cash right?"

• WRONG!  When calculating TOTAL REVENUE it also includes sales made 'ON CREDIT' (yet to be received aka 'accounts receivable') while TOTAL COSTS includes supplies that you have bought 'ON CREDIT' (yet to have paid for 'accounts payable'), which means that actual cash inflows and outflows not yet been received or paid as such we can say that REVENUE ≠ CASH INFLOW. and COSTS ≠ CASH OUTFLOW

• It is therefore possible for a firm to be profitable but cash deficient.

• To understand the importance of working capital we should first show you a scenario when it might appear not that important🤔. If CASH INFLOW ALWAYS COMES BEFORE CASH OUTFLOWS and you always sell your stock, then why would you need to keep surplus liquids assets, such as cash, accounts receivable or stock? Think about this scenario!

--SCENARIO: 'NO WORKING CAPITAL'--

1. Your supplier gives you stock with 1 months trade credit.

2. All stock is sold to the customer in the month who pay immediately.

3. You pay your expenses with the inflow at the end of the month.

4. You also pay your suppliers with the inflow at end of month.

5. As the owner you keep the profit as 'personal income'....

6. ...and we go again... new stock arrives.

So, no need for working capital right???

• Hmmmmm!!! 🤔well as you can see this scenario relies on some very unrealistic assumptions that are almost TOO PERFECT TO BE REAL.

🚨⚠️ Let's look at the KEY ASSUMPTIONS & RISKS⚠️🚨 

• 1. All stock are sold within 1 month Assumes 100% sell-through rate with no unsold inventory. In reality, demand fluctuates, trends change, and some stock might remain unsold, meaning you have working capital in the form of stocks.

• 2. All customers pay immediately Unrealistic for B2B or many retail scenarios — delayed payments, bad debts, or returns are common. Also if a competitor is offering customers credit terms then you may lose them.

• 3. No cash needed before receiving payment Assumes expenses (e.g. wages, utilities, rent) align perfectly with cash inflow — in reality, some payments may be due before cash is received. Do you think all bills arrive at the end of the month? 

• 4. No stock or cash buffer is needed Leaves no room for emergencies, delayed shipments, spoilage, or increased demand — you're vulnerable to disruptions. What if there is s delay with delivery and the customer is waiting, yet there is no stock, hence no income...

• 5. Supplier gives generous trade credit every month Assumes continued credit terms from suppliers with no deposit or upfront payment — risky if your creditworthiness changes. Also creditors may get better terms at your competitors and decide not to supply you anymore.

• 6. Owner can extract profit regularly Taking all profit leaves no retained earnings for growth, contingencies, or reinvestment — this is financially fragile. 

• 7. No inventory buildup needed for growth Assumes flat or predictable demand — growth or seasonal spikes require investment in extra stock beforehand.

So you can see that having working capital in the form of these three is MUCH LESS RISKY:

• • • • 💸 Cash savings from previous sales – Ready and reliable

      • 💸 Money owed to you by customers (debtors)

      • 📦 Unsold stock – If it's still in demand, you can turn it back into cash.

• So in most cases a firm will ALWAYS have some form of working capital and apart from the cash component (If you have any), there will of course be a TIME PERIOD in which it takes for you turn your stocks into cash and/or receive your debtors payments as well as pay creditors for any new stock ordered. This time period is called the WORKING CAPITAL CYCLE   

• The working capital cycle (also called the cash conversion cycle) is the amount of time it takes for a business to convert its investments in inventory and other resources into cash from sales.

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• It includes:

• Buying inventory – paying suppliers.

• Selling goods or services – turning that inventory into sales.

• Receiving payment – collecting cash from customers.

• In simple terms:

• It’s how long it takes a business to go from spending cash (to buy stock) to getting cash back (from customers).

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• Formula:

• Working Capital Cycle = Inventory Days + Receivables Days − Payables Days

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• Inventory Days: How long stock is held before being sold.

• Receivables Days: How long customers take to pay.

• Payables Days: How long the business takes to pay suppliers.

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• Goal:

• A shorter cycle means a business gets cash back faster, improving cash flow and efficiency.

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• Would you like a diagram or classroom activity to go with this explanation?

• A CASH FLOW FORECAST is a financial tool used by businesses to predict the flow of money in and out over a specific period. It estimates future cash inflows from sales, investments, or other income sources, and outflows such as expenses, salaries, rent, and loan repayments. This helps businesses plan for sufficient liquidity to meet their obligations.

• Let's look at some sources of cash inflows and outflows, and how easy they are to forecast!

• Are they related? Well it would be very hard to explain why they wouldn't be, as if you think about any INVESTMENT you make, would likely be for the reason of eventually making PROFIT, howeer you would likely have to make a large CASH OUTFLOW at the beginning right?