AP® Business with Personal Finance review sheet from Aim for Five (aimforfive.com/business-finance/units/3/3-8)
Unit 3 · Topic 3.8
3.8 The Cash Flow Statement
A cash flow statement tracks the actual cash moving in and out of a business over a period. A business can show a profit and still run out of cash, so owners, lenders and investors watch cash flow closely.
Key terms
- cash flow statement
- cash inflow
- cash outflow
- cash balance
- negative cash flow
- accounts receivable
Cash in, cash out
A cash flow statement shows how cash inflows and outflows changed the business's cash balance over a reporting period. Ending cash = starting cash + inflows − outflows. Cash flow for the period can be positive (more came in than went out) or negative.
| Item | Inflow or outflow? | Example |
|---|---|---|
| Payments from customers | Inflow | A store pays its invoice |
| Interest or dividends earned on investments | Inflow | Interest on the business's savings |
| Selling the business's assets | Inflow | Selling an old delivery van |
| New financial capital | Inflow | A new bank loan or selling stock |
| Paying employees and suppliers | Outflow | Payroll, a lumber order |
| Interest on loans and taxes | Outflow | Monthly loan interest, quarterly taxes |
| Buying assets | Outflow | A new saw |
| Repaying loans and paying dividends | Outflow | Paying back loan principal, a dividend to owners |
Why cash matters so much
Businesses watch their cash balance to be sure they can pay regular bills like payroll and rent, repay lenders and handle surprises. Lenders, suppliers, employees and shareholders use the cash flow statement to judge whether the business can pay what it owes them.
Profit and cash are not the same. A business records a sale when it happens, but a customer might not pay for 30, 60 or 90 days. Meanwhile, workers and suppliers want to be paid now. So negative cash flow can push even a profitable business toward shutting down or bankruptcy.
Profit and cash can move in opposite directions
- A $10,000 sale to a customer who pays in 60 days raises revenue and profit now, but cash only rises when the payment arrives.
- A new $50,000 bank loan raises cash right away, but it isn't revenue, so profit doesn't change.
- Buying a $20,000 machine cuts cash right away, even though it will be used to make products for years.
- Repaying loan principal (the amount borrowed) is a cash outflow, but only the interest counts as an expense on the income statement.
Fixing a cash crunch
Individuals face the same problem. A person with a good salary can still be short of cash if rent is due on the 1st and payday is on the 15th, which is why an emergency fund helps.
- Raise more money, for example with a short-term loan or a line of credit (a loan you can draw on when needed).
- Collect accounts receivable faster, such as by offering a small discount for paying early.
- Get better terms from suppliers (more time to pay) or from lenders (lower payments).
Worked examples
Try each one yourself first, then open the solution.
- Example 1Calculator allowed
A profitable business running short of cash
A furniture maker starts January with $20,000 in cash. Big store orders mean its income statement shows a profit, but stores pay 60 days after delivery. Cash in and out: January in $30,000, out $41,000; February in $32,000, out $44,000; March in $45,000, out $40,000. Track the cash balance and explain the problem.
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- Step 1: January: $20,000 + $30,000 − $41,000 = $9,000.
- Step 2: February: $9,000 + $32,000 − $44,000 = −$3,000. It can't actually go below zero; it means the business would be $3,000 short of paying its bills.
- Step 3: March: −$3,000 + $45,000 − $40,000 = $2,000, as January's sales are finally paid.
- Step 4: The business is profitable, but cash from customers arrives two months after it pays workers and suppliers. Without a fix, it would miss February payments.
Answer: Balances: $9,000 (Jan), −$3,000 (Feb), $2,000 (Mar). To get through February it could take a short-term loan, ask stores to pay faster or ask suppliers for more time.
Common mistakes
- Assuming a profitable business always has cash. Timing of payments can leave it short.
- Counting a new loan as revenue. A loan is a cash inflow, but not revenue on the income statement.
- Forgetting that buying equipment and repaying loans are cash outflows even though they aren't operating expenses.
On the exam
- Expect a table of monthly inflows and outflows: compute the ending balance, spot the month cash goes negative, and recommend a fix.
- Be ready to sort items into inflows and outflows, and to explain why negative cash flow is dangerous even when net income is positive.
Connected topics
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Check yourself: 3.8 The Cash Flow Statement
4 questions on 3.8 The Cash Flow Statement. Pick an answer to see if you got it, and why.
| Item | January | February | March |
|---|---|---|---|
| Starting cash balance | $12,000 | (not shown) | (not shown) |
| Cash from customers | $30,000 | $22,000 | $35,000 |
| New bank loan | $0 | $10,000 | $0 |
| Payments to employees | −$18,000 | −$18,000 | −$18,000 |
| Payments to suppliers | −$15,000 | −$14,000 | −$12,000 |
| Loan repayment | −$1,000 | −$1,000 | −$1,500 |
Cash flow statement for Sprout Learning, a hypothetical tutoring company. Each month's ending balance becomes the next month's starting balance.
What was Sprout Learning's cash balance at the end of February?
In which months did Sprout Learning have negative cash flow?
How is the $10,000 bank loan in February shown on the cash flow statement?
Many of Sprout's customers pay 60 days after a tutoring session. Which step would most directly improve the company's cash flow?
0 of 4 answered