• 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) while TOTAL COSTS includes supplies that you have bought 'ON CREDIT' (yet to have paid for), which means that actual cash inflows and outflows not yet been received or paid as such we can say that REVENUE ≠ CASH INFLOW.

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

• Many people forget that to run a business, you constantly need to restock inventory, buy raw materials, and pay staff—these are essential, ongoing costs. That means you need money available at all times to cover these expenses. If you don’t, your business could grind to a halt.

• Take the example of a pancake seller. If they earn $1,000 this month but spend all of it, they won’t have anything left to buy flour, eggs, or pay their assistant for the next month. That’s why businesses need some excess funds, known as working capital, to keep operating.

  • • • Working capital can be:

• Cash already in the bank

• Stock (that can be sold soon)

• Money owed by customers (accounts receivable)

• If that’s not enough, the business may need to borrow money temporarily to stay afloat.

• Because there's often a delay between spending money and getting paid, managing cash flow becomes critical. A business can look profitable on paper, but still struggle if it doesn't have enough liquid assets to pay immediate bills.

• So, is making a profit enough?

• No—because profit might be tied up in things like unpaid customer invoices or unsold stock. What the business really needs is excess liquid assets (like cash or quickly accessible funds) to keep going.

• To understand it's importance let's imagine that the current ratio is exactly ONE meaning that all cash coming from the sale of stock, and customers in is just enough to pay what’s owed right now, but there’s nothing left over, no excess cash, stock or accounts receivable, how do you get hold of cash to restock?, Or to pay for small emergencies?, Or to invest in new opportunities?...

• Even the above scenario is unlikely as it assumes all buyers pay you before your creditors want paying and so on...

• So an excess of current assets over liabilities is very desirable if the business wishes to continue as it needs to buy more stock to sell right?

• Knowing this need for cash it is vital that management plan/forecast their needs accurately and this even includes borrowing when they know that money will be inflowing and and debts can easily be paid back. 

• THE WORKING CAPITAL CYCLE is the time it takes for a business to turn its NET CURRENT ASSETS into cash.

• We already explained that net current assets is the excess of current assets over current liabilities which includes cash itself as well as stock and cash receivable, and we say that both stock and cash receivable represent cash that is 'tied-up', until they are converted into physical cash which can then be used to buy more.

• Think about it cash flows out when you buy stocks

• Buy raw materials or stock (inventory)

• You spend money to buy t-shirts from a supplier. This money is outgoing cash.

• Hold inventory which is part of your cash tied up in stock

• The t-shirts are stored in your shop. While they sit on the shelf, no cash is coming in, but your money is still tied up.

• Finally you sell the product

• A customer buys a t-shirt. This is a sale—but you might not get the money immediately.

• Eventually you receive payment in cash

• If the customer pays with cash or card right away, great! But if you gave them credit (e.g., they’ll pay in 30 days), you’re still waiting for the cash.

• Only once you get the cash can you restock

• Once you get paid, you use that money to buy more t-shirts—and the cycle starts again.

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• ⏱️ Why It Matters

• A short working capital cycle = money comes back quickly = easier to pay bills and grow the business.

• A long working capital cycle = money is tied up too long = risk of cash flow problems.

• It’s all about cash flow—how quickly money flows in and out of the business.Note that as time is a factor in how quickly working capitakl can be worked out due to ACCOUNTS PAYABLE and ACCOUNTS RECEIVABLE being part of current liabilities and current assets                                                                                                                                                                                                                                                                                                                                                                                                                                   

• 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?