Cash flow management for a growing business - the cash flow statement and the distinction between profit and cash, working capital management (current assets and current liabilities, the cash conversion cycle), and strategies to manage cash flow gaps during growth (overgrowth/overtrading risk)

What this dot point is asking

QCAA wants you to manage the cash of a growing business: to explain why profit and cash differ, read a cash flow statement, understand working capital and the cash conversion cycle, recognise the overtrading risk that growth creates, and recommend strategies to keep cash flowing. The marks are in showing that a profitable business can still fail if it runs out of cash.

The answer

Profit is not cash

This gap is the central idea of the dot point. A sale made on 30-day credit counts as profit today but does not become cash for a month. Meanwhile wages, rent and suppliers must be paid now.

The cash flow statement

The cash flow statement tracks the actual movement of cash in and out over a period, grouped into three activities.

The closing cash balance is the opening balance plus net cash flow. A cash flow forecast applies the same structure to future periods so the business can see gaps before they happen.

Working capital

• Current assets include cash, accounts receivable (money owed by debtors) and inventory (stock).
• Current liabilities include accounts payable (money owed to creditors) and short-term debt.

Positive working capital means the business can cover its short-term commitments. But cash tied up in stock and unpaid invoices is not available to spend, so managing the composition of working capital matters as much as the total.

The cash conversion cycle

The cash conversion cycle is the time between paying for inputs and collecting cash from the customer. The longer the cycle, the more cash is tied up.

• Inventory days - how long stock sits before it is sold.
• Plus debtor days - how long customers take to pay after the sale.
• Minus creditor days - how long the business takes to pay its suppliers.

A growing business wants to shorten the cycle: hold less stock for less time, collect from debtors faster, and use reasonable supplier credit, so cash is freed to fund growth.

Overtrading: the growth trap

This is why growth (Unit 2) makes cash management critical: the faster the business grows, the bigger the timing gap between cash out (now) and cash in (later).

Strategies to manage cash flow gaps

Speed up cash in.

• Invoice promptly and follow up debtors.
• Tighten credit terms (shorter payment periods, credit checks on new customers).
• Offer small early-payment discounts.
• Take deposits or progress payments on large jobs.

Slow cash out.

• Negotiate longer payment terms with suppliers.
• Lease rather than buy major assets to spread the cash cost.
• Time large discretionary purchases for high-cash periods.

Arrange a buffer.

• Keep a bank overdraft or line of credit for timing gaps, paying interest only on what is used.
• Hold a cash reserve.

Plan ahead.

• Prepare a rolling cash flow forecast so gaps are seen weeks in advance and acted on early.

Examples in context

Example 1. Overtrading at a growing wholesaler. A Brisbane homewares wholesaler wins a large retail account and doubles its orders. It must buy stock and pay the shipping upfront, but the retailer pays on 60-day terms. Although each sale is profitable, the business pays for three months of stock before the first big payment arrives, and nearly cannot meet payroll. It survives by negotiating a $150,000 overdraft and asking the retailer for a deposit on future orders, then prepares a weekly cash flow forecast. The episode shows a profitable business almost failing on cash, not profit.

Example 2. Working-capital discipline at scale - the supermarket model. Australian supermarkets run a very short, even negative, cash conversion cycle: customers pay cash at the register immediately, stock turns over in days, yet suppliers are paid on 30 to 60-day terms. The business collects cash before it has to pay for the goods, so growth funds itself rather than draining cash. This is the favourable end of working-capital management that a growing business aims to move toward.

Try this

Q1. Explain, with an example, why profit and cash are not the same thing. [2 marks]

• Cue. Profit is recorded when a sale is earned (accruals); cash arrives when the customer actually pays. A credit sale is profit today but cash in 30 days.

Q2. A business has current assets of $180,000 (cash$20,000, debtors $60,000, stock$100,000) and current liabilities of $110,000. Calculate working capital and comment on what is tying up cash. [3 marks]

• Cue. Working capital = 180,000 - 110,000 = $70,000 (positive). But$160,000 is locked in debtors and stock; only $20,000 is liquid cash, so collecting debtors and trimming stock would free cash.

Q3. A rapidly growing business is profitable but keeps running short of cash. Identify the likely cause and recommend three strategies to fix it. [4 marks]

• Cue. Cause: overtrading (growth outpaces cash). Strategies: speed up cash in (tighter credit terms, faster invoicing, early-payment discount), slow cash out (longer supplier terms, lease assets), arrange a buffer (overdraft), and forecast cash flow ahead.