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Get to Grips With Book Keeping: Cash flow

by Andy Lymer and Nick Rowbottom

Cash flow is often described as the blood of business, due to its importance in ensuring commercial survival. Cash flows are considered to be distinct from profits in accounting due to the accruals principle. This dictates that profits are recognised in the accounts when a transaction occurs, and not when cash flows are transferred.

This leads to the situation, particularly prevalent in new, small businesses, where they can be generating decent profits yet run out of cash and become insolvent. This can happen where a new business is generating plenty of sales transactions on credit, but is slow in collecting the resultant cash flows from debtors (who often represent larger businesses who can dictate credit terms). This is often combined with the need for small businesses to expend cash by investing in fixed assets and expanding their workforce or holdings of stock.

Where cash may be insufficient to fund both the operating cycle (the gap between buying, selling and collecting cash) and the expansion of the business, the business is often described as ‘overtrading’. This can be remedied by injecting further equity capital into the business, or taking on further liabilities such as bank loans. Most small business plans specifically aim to ensure that businesses have sufficient cash flows to funding start-up and expansion while also covering the operating cycle.

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