“Profit does not pay the bills” is one of those phrases that can sound like an accounting cliché, right up until you find yourself running a profitable business that cannot meet its payroll.

I have seen businesses with growing sales, a healthy order book and apparently respectable profits still struggle to pay suppliers, settle their VAT or take money out of the business. On paper, they appear successful. In the bank account, the situation looks very different.

This happens because profit and cash are not the same thing.

A business can record revenue when it raises an invoice, but it may not receive the money for another 30, 60 or even 90 days. In the meantime, it may already have paid the wages, subcontractors, materials and overheads needed to deliver the work.

Consider a simple example.

A business completes a £100,000 contract and earns a £20,000 profit. That sounds like a good result. But before receiving anything from the customer, it has to pay £55,000 for labour and materials and another £25,000 towards its overheads.

If the customer does not pay for 60 days, the business must find £80,000 to finance the work during that period. The contract may be profitable, but the profit does nothing to pay this month’s wages because the cash has not yet arrived.

That gap between making money and receiving money is where many otherwise good businesses get into difficulty.

The problem is that most businesses look at their financial position through only one lens.

• Some concentrate on profit. If the management accounts show a profit, they assume the business is financially healthy.
• Others focus on the bank balance. If there is money in the account, they assume the business can afford to spend it.
• Others prepare a cash flow forecast and believe that, because they can see when the money may run out, they understand their cash position.

Each view tells us something useful. None tells us everything. To manage cash properly, I believe we need to look at the business from three connected but distinct financial perspectives.

Profitability

Profitability tells us whether the business is creating financial value. Is it selling its products or services for more than they cost to provide? Are its gross margins strong enough? Can those margins support its overheads? Is the business making a sustainable operating profit?

These are fundamental questions. A business that cannot make a profit will eventually run out of cash unless its owners or lenders continue putting more money into it.

But profitability does not tell us when the money will be received or paid.

A sale can be profitable and still create immediate cash pressure. A growing order book can increase reported profit while simultaneously draining the bank account. Profitability tells us whether the commercial model works. It does not tell us whether the business can meet next Friday’s payroll.

Operational Cash Flow

Operational cash flow helps us understand whether the normal activities of the business are generating or consuming cash.

It looks beyond the reported profit and considers the way money moves through the operating cycle. How long do customers take to pay? How quickly must suppliers be paid? How much cash is tied up in stock or work in progress? Are margins creating enough cash to support the overhead structure?

This is important because money can enter a bank account from several sources.

A business might receive a new loan, an injection from its owners or the proceeds from selling an asset. These transactions increase the bank balance, but they do not mean the underlying business has become better at generating cash.

A company could have £100,000 in the bank after taking out a loan and still be losing £20,000 every month through its normal operations. The bank balance may look reassuring, but it is providing a false sense of security. Unless the operational weakness is corrected, that £100,000 will gradually disappear, and the loan will still need to be repaid.

Operational cash flow helps strip away that distortion. It asks a more revealing question:

“If we remove new borrowing, owner investment and exceptional cash movements, is the underlying business producing enough cash to support itself?”

That makes operational cash flow more than an accounting number. It becomes a measure of the strength of the business’s financial engine.

Cash Flow Forecasting

A cash flow forecast looks forward.

It estimates when money will enter and leave the bank account and shows the effect on the future cash balance. A useful forecast should include expected customer receipts, wages, supplier payments, tax liabilities, loan repayments, capital expenditure and other significant commitments.

Its purpose is to provide advance warning.

If the forecast shows that the bank balance will fall below a safe level in eight weeks, management has time to act. The business might accelerate customer collections, delay non-essential expenditure, negotiate different payment terms or arrange funding before the situation becomes urgent.

Without that visibility, the first warning may be a failed payment or a call from the bank.

However, a forecast has an important limitation.

It can show us when cash may run out without necessarily explaining why.

For example, a forecast might identify a £75,000 cash shortage in three months. That shortage could be caused by a major customer paying later than expected. It could result from rapid growth requiring additional working capital. It could be caused by an underpriced contract, falling margins or overheads that have become too high.

Those are very different problems, and they require very different solutions.

A temporary timing gap might justify an overdraft or working-capital facility. A permanent operating loss requires changes to pricing, costs or the underlying business model. Borrowing may disguise that problem temporarily, but it cannot solve it.

This is why I believe profitability, operational cash flow and cash flow forecasting must be used together.

• Profitability tells us whether the business is creating value.
• Operational cash flow tells us whether its everyday trading activity is converting that value into cash.
• Cash flow forecasting tells us whether the timing of future receipts and payments will leave the business with enough money to meet its commitments.

Put simply:

“A cash flow forecast tells you when cash may run out. Operational cash flow helps explain why.”

That distinction becomes particularly important when a business is considering funding.

The natural response to a forecast cash shortage is often to ask how much the business can borrow. But that is rarely the best starting point. Before arranging funding, I want to understand what has created the requirement.

Is the business funding a profitable contract before the customer pays? Is growth temporarily absorbing working capital? Is cash trapped in overdue invoices? Or is the business borrowing because its prices, margins or cost structure no longer work?

Funding can be an effective way to bridge a temporary and clearly understood cash flow gap. It can help a business take advantage of growth, invest in productive assets or deliver work that will generate future cash.

But funding also creates future commitments. Interest must be paid. Capital must be repaid. Security or personal guarantees may be required. If the underlying business is already consuming cash, borrowing can make the eventual problem larger rather than solve it.

Throughout this guide, I am going to examine how businesses can understand cash more clearly, build more useful forecasts and make better funding decisions.

The aim is not merely to predict when the bank balance will become uncomfortable. It is to understand the story behind that balance, where the cash is being generated, where it is becoming trapped and whether external funding is supporting a genuine opportunity or concealing a deeper problem.

1. What Is Cash Flow, and Why Is It Different From Profit?

Cash flow is the movement of money into and out of a business. When customers pay, cash flows in. When the business pays wages, suppliers, tax, loan instalments or other expenses, cash flows out.

Profit is calculated differently. It measures the financial result produced by the business over a particular period by matching income with the costs incurred to generate it.

That distinction matters because the date on which income or expenditure appears in the accounts is not necessarily the date on which the money moves through the bank. I find it helpful to think of profit as a measure of performance and cash flow as a measure of movement.

Profit answers: Did the business generate more income than it incurred in costs?

Cash flow answers: What money did the business actually receive and pay during the period?

The two are connected, but they rarely move in perfect alignment.

Unpaid Sales Invoices Can Create Profit Without Cash

Suppose I complete £30,000 of work in March and raise an invoice on 31 March. The customer has agreed to pay within 60 days.

Provided the work has been completed and the income has been earned, the £30,000 sale will normally appear in the March accounts. It will contribute to March’s profit.

However, no cash has been received.

Instead, the £30,000 appears as a debtor, money owed to the business by its customer. The accounts show that the business has earned the income, but the bank account remains unchanged.

If the customer pays at the end of May, the cash arrives two months after the profit was reported.

This delay can be manageable when the business has adequate cash reserves. It becomes more dangerous when several large customers pay late or when the business has committed most of its available cash to delivering the work.

The business may therefore report a strong month while becoming less able to meet its immediate commitments.

An invoice is not cash. It is a claim for cash.

Until the customer pays, the business is effectively financing the customer.

Supplier Payments Can Reduce Cash Before They Reduce Profit

The timing difference can also work in the opposite direction.

Suppose I pay a supplier £24,000 in advance for materials that will be used across several contracts over the next six months.

The full £24,000 leaves the bank immediately. From a cash flow perspective, the effect is instant.

But the entire amount may not reduce profit in the month it is paid. If only £4,000 of those materials are used during the first month, only that portion may be charged against the income for that period. The remaining materials continue to be held by the business for future work.

This means the business could experience a £24,000 cash outflow while recognising only £4,000 as a cost in that month’s profit calculation.

The profit and loss account may therefore look reasonably healthy while the bank balance has fallen significantly.

This is one reason I am cautious when someone tells me that a business is performing well based solely on its reported profit. I also want to know how much cash has been committed to suppliers and how quickly that investment will be converted into customer receipts.

Stock Ties Up Cash Until It Is Sold

Stock provides another clear example of the difference between profit and cash.

Imagine a retailer buys £50,000 of stock in preparation for a busy season. The supplier requires immediate payment, so £50,000 leaves the bank.

The purchase does not necessarily create an immediate £50,000 loss.

The unsold goods are recorded as stock because the business still owns something of value. The cost generally becomes part of the profit calculation when the stock is sold.

If the business sells half of the stock during the season, only the cost relating to those sales is charged against the revenue. The other half remains on the balance sheet as stock.

From an accounting perspective, that is logical. The remaining stock may generate income in the future.

From a cash perspective, however, the money has already gone.

If the stock sells slowly, becomes obsolete or has to be discounted, the business can have a large amount of cash trapped on shelves. The accounts may show a valuable stock asset, but that asset cannot normally be used to pay this week’s wages without first being sold and converted back into money.

The practical question is not simply how much stock the business owns. It is how quickly and profitably that stock can be turned into cash.

Work in Progress Can Create the Same Problem

The same principle applies to service, construction and project-based businesses through work in progress.

Suppose a company begins a four-month project. During the first two months, it spends £70,000 on labour, subcontractors and materials but cannot invoice the customer until a contractual milestone is reached in month three.

The company is creating something of value. Depending on the accounting treatment, some of the expenditure may be held as work in progress rather than reducing profit immediately.

But the employees, subcontractors and suppliers still need to be paid.

The project may ultimately generate a good margin, but the business must finance the work until it reaches the invoicing milestone—and then potentially finance the customer’s payment terms after the invoice is raised.

A project that looks profitable in the estimate can therefore produce severe cash pressure during delivery.

This is why I consider payment structure to be part of pricing and project management, not simply an administrative detail. Deposits, stage payments and carefully chosen billing milestones can materially reduce the amount of cash the business must risk.

Tax Creates Cash Outflows at Different Times From the Profit

Tax is another area where profit and cash frequently become confused.

VAT is the clearest example.

Suppose a business invoices a customer £12,000, consisting of £10,000 plus £2,000 VAT. When the customer pays, £12,000 enters the bank.

However, the business has not earned all £12,000. Subject to any allowable input VAT, the £2,000 VAT belongs to HMRC.

If the business treats the full receipt as available cash and spends it, it may struggle when the VAT return becomes payable.

The bank balance was correct, but the interpretation was wrong. Some of the visible cash was already committed.

Corporation tax creates a different timing issue. A company may make a profit throughout the year, but the associated corporation tax is generally paid later. Unless the business regularly reserves for that liability, the eventual payment can produce a significant fall in cash.

PAYE and National Insurance create similar pressures. The cost of employing someone may already be reflected in the profit calculation, but the deductions and employer liabilities must still be paid to HMRC according to the relevant payment timetable.

Tax should never be treated as a surprise. But without proper forecasting and cash separation, predictable tax liabilities frequently become cash flow emergencies.

Loan Repayments Reduce Cash but Do Not Reduce Profit in the Same Way

Loan repayments are often misunderstood because each payment can contain two separate elements:

• Interest.
• Repayment of the amount originally borrowed.

The interest is normally a cost to the business and reduces profit.

The capital repayment does not normally reduce profit because it is paying back a liability rather than purchasing a new good or service. Nevertheless, the entire payment leaves the bank account.

Suppose a business makes a monthly loan payment of £5,000, of which £1,000 is interest and £4,000 is capital repayment.

The profit and loss account may show a finance cost of £1,000. The cash flow shows an outflow of £5,000.

Across a year, that difference amounts to £48,000.

A business could therefore report an annual profit of £60,000 but use £48,000 of cash to repay loan capital. Before considering tax, dividends, investment or changes in working capital, only £12,000 of that apparent profit would remain as cash.

This is why I do not assess borrowing affordability using profit alone. I want to know whether the business will generate sufficient cash, at the right times, to meet both the interest and the capital repayments.

Capital Expenditure Uses Cash Before It Reduces Profit

Capital expenditure includes money spent on assets expected to benefit the business for more than one accounting period. This could include:

• Machinery.
• Vehicles.
• Computer equipment.
• Office improvements.
• Production equipment.
• A new business system.

Suppose a company purchases a machine for £60,000 and pays for it immediately.

The bank balance falls by £60,000.

However, the business would not normally recognise the entire £60,000 as an expense in that month’s profit and loss account. Instead, the machine is recorded as an asset and its cost is spread over its expected useful life through depreciation.

If the machine is depreciated over five years, the annual depreciation charge might be £12,000. Ignoring any timing conventions, that would represent £1,000 per month in the profit calculation.

The cash outflow was £60,000, but the initial monthly cost shown against profit may be only £1,000.

This can create an enormous difference between reported profit and cash movement.

The purchase may still be an excellent decision. The machine might increase capacity, reduce labour costs or create a valuable new revenue stream. But the business must be able to finance the initial expenditure.

This is also why the method of funding matters. Paying £60,000 immediately has a very different short-term cash effect from financing the machine over five years. Finance may increase the total cost through interest, but it can more closely align the cash payments with the period in which the asset generates value.

Profit Can Exist Without Positive Cash Flow

Once these timing differences are combined, it becomes easier to see how a profitable business can experience negative cash flow.

Imagine a business reports a monthly profit of £25,000. During the same month:

• Customer invoices increase by £40,000 because clients have not yet paid.
• The business buys £20,000 of additional stock.
• It makes £8,000 of loan capital repayments.
• It purchases £15,000 of new equipment.
• It pays a VAT liability of £12,000.

The business may genuinely have made a £25,000 profit, but that does not mean its bank balance will increase by £25,000.

Cash has been absorbed by debtors, stock, debt repayments, investment and tax. Without sufficient reserves or external finance, the business may come under pressure despite its reported profitability.

The reverse can also happen.

A business may receive a large customer deposit, draw down a new loan or delay paying suppliers. Its bank balance rises even though it has made a loss.

Positive cash movement does not automatically mean the business is profitable, just as profit does not automatically mean it is generating cash.

Neither Measure Should Be Used in Isolation

I would not choose between profit and cash flow because a well-managed business needs to understand both.

Profitability tells me whether the business model is economically sustainable. If the company repeatedly sells below the cost required to provide its products or services, cash will eventually disappear regardless of how carefully it is managed.

Cash flow tells me whether the business can meet its commitments as they fall due. Even a profitable company can fail if it cannot pay employees, suppliers, lenders or HMRC at the required time.

• Looking only at profit can hide immediate financial pressure.
• Looking only at cash can hide losses, growing liabilities or the temporary effect of borrowing.

The real insight comes from understanding how profit is being converted into cash—and identifying where that conversion is being delayed, diverted or lost.

The most important practical lesson is straightforward:

“A profitable sale only becomes useful cash when the money is collected.”

Until then, the business may have created income and earned a margin, but it is still carrying the cost of the sale. The longer the delay between doing the work and receiving the money, the more cash the business must provide from its own reserves or obtain from someone else.

 

When a profitable business experiences cash flow problems, the immediate assumption is often that something must be wrong with the accounts. If the business is making money, surely there should be money in the bank?

Unfortunately, it does not work that way.

Profit measures whether the business is earning more than it costs to operate. It does not guarantee that the cash will be available when wages, suppliers, tax or loan repayments become due.

In practice, businesses rarely receive money from customers at precisely the same time as they have to pay everyone involved in delivering the work. That gap creates a funding requirement, even when the underlying sale is profitable.

The greater the difference between when the business spends money and when it collects it, the greater the cash flow risk.

Working-Capital Timing Creates the Cash Flow Gap

Working capital is the money a business needs to finance its everyday trading cycle. Most businesses follow some version of this sequence:

1. Buy materials, stock or services.
2. Pay employees or subcontractors.
3. Deliver the product or complete the work.
4. Raise an invoice.
5. Wait for the customer to pay.

Cash normally leaves the business during the early stages of this process. It may not return until much later.

Consider a manufacturer that receives an order worth £150,000. The order is expected to produce a gross profit of £45,000, so commercially it appears attractive. However, the manufacturer must initially spend:

• £60,000 on materials.
• £30,000 on labour.
• £15,000 on other production costs.

That means £105,000 must be found before the customer pays. If the work takes eight weeks to complete and the customer then has 60-day payment terms, the manufacturer could be financing the order for approximately four months.

The eventual £45,000 gross profit does not eliminate that requirement. It only means that, once the entire transaction is completed and the customer has paid, the business should receive more than it spent.

During the intervening period, the business needs £105,000 from its existing cash reserves, supplier credit, customer deposits or external funding.

This is the working-capital gap. “The business is not necessarily unprofitable. Its money is simply committed elsewhere in the trading cycle.”

Growth Can Increase Cash Pressure

Growth is usually treated as the solution to financial difficulty. In reality, rapid growth can be one of the most demanding periods for a business’s cash flow.

A growing company may need to:

• Recruit additional employees.
• Increase subcontractor capacity.
• Buy more stock and materials.
• Take on larger premises.
• Add vehicles or machinery.
• Increase marketing expenditure.
• Invest in new systems.
• Provide customers with credit.

These costs often arise before the additional sales are collected.

Suppose a business currently generates £200,000 of monthly revenue and plans to grow to £300,000. Its customers normally pay 60 days after invoicing, while most of its employees and suppliers must be paid within 30 days.

To support the additional £100,000 of monthly revenue, the business may need to finance two months of increased activity before the first additional receipts arrive.

If the direct cost of delivering those extra sales is £70,000 per month, growth could create an additional working-capital requirement of £140,000 before considering recruitment costs, equipment or increased overheads.

The business may become more profitable as it grows, but its bank balance can deteriorate during the transition.

This is what makes growth particularly dangerous. The management team sees rising revenue, a larger order book and stronger projected profits. Those positive signals can obscure the increasing amount of cash being absorbed.

• A business can therefore grow itself into a cash crisis.
• The faster it grows, the faster it may consume cash.

Slow-Paying Customers Force the Business to Provide the Funding

A customer who pays late does more than create an administrative inconvenience. They increase the amount of money the business must provide to support the sale.

Imagine a company raises £100,000 of invoices every month on 30-day terms.

If customers pay as agreed, the business may consistently have around one month’s revenue tied up in debtors. If the average payment period drifts to 60 days, approximately two months of revenue may be outstanding.

• The company now has an additional £100,000 trapped in unpaid invoices.
• If payment slips to 75 days, the funding requirement increases further.

Nothing may have changed in the profit and loss account. The business could be reporting the same sales and margins. But the bank balance becomes weaker because the cash conversion cycle has lengthened.

The business still has to pay its own commitments. Employees will not normally wait an additional month because a customer is late. HMRC will not extend a tax deadline because the sales ledger has not been collected. Many suppliers will suspend further deliveries if their invoices are overdue.

The business is therefore placed in a difficult position: it must either use its own reserves or borrow money to compensate for the customer’s delayed payment.

In effect, the customer is financing their business with the supplier’s money.

This also means that late payment has a real financial cost. If the business needs an overdraft or invoice-finance facility to replace the missing cash, interest and fees reduce the margin earned on the sale.

A transaction that looked attractive when it was priced may become much less valuable once the cost of financing the customer is included.

Upfront Project Costs Can Consume Cash Before Any Invoice Is Raised

Project-based businesses are especially exposed because they often incur substantial costs before reaching an invoicing milestone. A company may win a profitable contract but need to pay for:

• Design and planning.
• Materials.
• Site preparation.
• Labour.
• Travel and accommodation.
• Equipment hire.
• Subcontractors.
• Insurance or performance guarantees.

If the contract allows the business to invoice only when a particular stage is completed, all the earlier expenditure must be financed.

Suppose a contractor wins a six-month project worth £500,000 with an expected profit of £100,000.

During the first two months, it incurs £140,000 of costs. The first contractual milestone allows it to raise an invoice for £175,000 at the end of month two, but the customer has 45-day payment terms.

The contractor may need to finance almost three and a half months of project activity before receiving the first meaningful payment.

If the milestone is delayed, the work is disputed or the customer takes longer to approve the invoice, the cash requirement increases again. The project could remain profitable overall while creating serious short-term financial pressure.

This is why I regard the payment schedule as a fundamental part of the commercial agreement. A profitable price is not enough. The contract must also provide a workable route from expenditure to collection.

Deposits, mobilisation payments, staged invoicing and shorter approval periods can reduce the amount of cash the business must commit. Without them, the company may win the work but lack the financial capacity to deliver it safely.

Tax Liabilities Can Make Available Cash Look Stronger Than It Is

Money in the bank is not always money the business can safely spend.

A portion may already be committed to VAT, PAYE, National Insurance or corporation tax.

The difficulty is that these liabilities are often paid after the activity that created them. This creates a period in which the cash remains visible in the bank account even though it effectively belongs elsewhere.

VAT is a common example.

A customer payment may include VAT collected on behalf of HMRC. Unless the business separates or reserves that amount, it can easily become absorbed into normal operating expenditure.

The problem emerges when the VAT return becomes due and the money is no longer available.

Corporation tax can create a similar issue. A profitable year may produce a substantial tax liability, but the payment date occurs later. If the owners see the year-end bank balance as free cash and use it for investment, drawings or dividends without reserving for tax, the company may struggle when the liability falls due.

PAYE and National Insurance create more frequent pressure because they are linked to payroll. A business may be able to pay its employees but then find that it has insufficient cash to pay the related deductions and employer liabilities.

Tax deadlines are generally predictable. Tax crises usually arise not because the liabilities were unknown, but because the cash was never reserved.

A business can therefore appear cash-rich while carrying substantial commitments that have not yet left the account.

Debt Repayments Can Absorb the Cash Generated by Profit

Borrowing can help a business manage working capital, invest in equipment or fund growth. But every borrowing decision creates future cash outflows.

Those outflows include both interest and repayment of the original capital.

The interest reduces reported profit. The capital repayment reduces cash but does not reduce profit in the same way. This distinction can create a significant affordability problem.

Suppose a business generates £120,000 of annual profit before tax. It also has annual loan repayments of £90,000, consisting of:

• £20,000 of interest.
• £70,000 of capital repayment.

The interest will be reflected as a cost in calculating profit. The £70,000 capital repayment will not be shown as a normal operating expense, but the cash must still leave the bank.

The remaining profit may therefore appear sufficient until the business also pays corporation tax, invests in replacement equipment or experiences an increase in debtors.

A profitable company can become over-borrowed when its scheduled repayments absorb too much of the cash generated through trading. This is why I always distinguish between whether a business can obtain finance and whether it can safely service that finance.

A lender’s willingness to provide money does not make the repayments affordable.

The test should be whether operational cash generation provides enough headroom to cover the repayments under realistic conditions, not only when everything goes according to plan.

Owner Drawings Can Remove Cash Faster Than the Business Produces It

A profitable business does not automatically have unlimited capacity to fund its owners’ lifestyles. Money taken from the company may include:

• Salary.
• Dividends.
• Director’s loan withdrawals.
• Reimbursement of personal expenditure.
• Pension contributions.
• Benefits or vehicles.
• Other discretionary payments.

Some of these may form part of the cost structure and some may be paid from profits after tax. But all of them ultimately affect cash. The risk arises when the amount withdrawn is based on reported profit or the visible bank balance rather than genuinely available cash.

Suppose a company reports £150,000 of annual profit. The owners decide to withdraw £100,000 because they believe the business can comfortably afford it.

However, during the same year:

• Debtors increase by £60,000.
• The company makes £25,000 of loan capital repayments.
• It spends £20,000 on equipment.
• Corporation tax of £30,000 becomes payable.

The business has not generated enough cash to support all those commitments and the planned withdrawals.

The owners may have a profitable company, but the profit is tied up in customers, assets and other obligations. Removing £100,000 could force the business to increase borrowing or delay payments to suppliers and HMRC.

This does not mean owners should not take money from their businesses. A business should ultimately reward the people who own it.

But drawings and dividends should reflect cash availability, future commitments and the level of reserves the business needs, not profit in isolation.

Cash Pressure Usually Comes From Several Sources at Once

Businesses rarely run out of money because of one perfectly isolated issue. More often, several manageable pressures combine.

A growing company may recruit additional people, purchase more stock and take on a major project. A large customer then pays late. A VAT quarter falls due. Loan repayments continue, and the owners withdraw money based on the previous year’s profit.

Individually, each decision may appear reasonable.

Together, they can produce a cash requirement far larger than management expected. Consider a business that begins the month with £120,000 in the bank. During the next eight weeks:

• £80,000 is committed to a new project.
• Debtor collections arrive £50,000 later than expected.
• A £35,000 VAT payment falls due.
• Loan capital repayments total £12,000.
• The owners withdraw £20,000.
• Growth increases the monthly payroll by £15,000.

The business has not necessarily stopped making a profit. But the timing and scale of its commitments have placed far more pressure on cash than the opening bank balance suggested.

This is why I do not treat cash flow management as simply watching the bank account. I want to understand the commitments building behind it.

Profitability Is Essential, but It Is Not Protection

A sustainably profitable business is in a much stronger position than an unprofitable one. Profit creates the potential to generate cash, build reserves, repay borrowing and fund future growth. But potential cash and available cash are not the same thing.

Profit can be:

• Tied up in unpaid customer invoices.
• Invested in stock.
• absorbed by work in progress.
• Committed to tax.
• Used to repay borrowing.
• Invested in equipment.
• Withdrawn by owners.

A business remains financially safe only when it understands how much cash its operations require, when that cash will be recovered, and what other commitments must be met in the meantime.

The central lesson is:

“Profitability does not remove cash flow risk because income and expenditure rarely happen at the same time.”

A profitable business can survive a temporary gap when it sees the gap early, understands its cause and has sufficient resources to fund it.

The danger comes when management assumes that profit will automatically turn into cash, and discovers too late that the money is still sitting in unpaid invoices, unfinished work or stock while the bills have already fallen due.

One of the most dangerous questions a business owner can ask is:

“How much money have we got in the bank?”

It sounds sensible, but the answer can be misleading. The balance shown by the banking app tells us how much money is currently sitting in the account. It does not tell us how much of that money has already been promised, committed or reserved for something else.

A business can have £200,000 in the bank and still be only days away from a cash flow problem.

Equally, a business with £30,000 in the bank may be in a perfectly manageable position if it has few immediate commitments and significant customer receipts arriving shortly. The number itself is not enough. I need to understand what sits behind it.

This leads to an important distinction between visible cash and available cash.

Visible Cash and Available Cash Are Not the Same Thing

• Visible cash is the amount currently shown in the bank account.
• Available cash is the amount the business can safely use after allowing for its known commitments and the minimum reserve it needs to operate.

A simplified calculation might look like this:

Available cash = Bank balance – committed payments – protected reserves

If the business has £150,000 in the bank but £110,000 is already needed for tax, payroll, suppliers and loan repayments, it does not really have £150,000 available.

It has £40,000, and even that may not be entirely safe to spend if it needs to retain a minimum operating reserve.

This distinction matters because business decisions are often made using visible cash.

A director sees a strong bank balance and decides that the company can afford a new vehicle, additional recruitment, an increased dividend or an early repayment of borrowing. The decision may appear affordable on the day it is made.

The problem becomes visible several weeks later, when the VAT payment, payroll and supplier run all fall due.

The bank balance was not wrong. It was simply incomplete.

VAT May Be in Your Bank Account, but It Is Not Your Money!

VAT is one of the clearest examples of visible cash creating false confidence.

Suppose a business receives £120,000 from customers during the month. If those sales were subject to VAT at 20%, part of the money collected represents VAT rather than income belonging to the business.

The precise amount payable to HMRC will depend on the VAT charged to customers, the VAT recoverable on eligible purchases and the business’s VAT accounting scheme. But the essential principle remains the same: some of the money received may already be owed to HMRC.

If the business spends the VAT element on wages, stock, equipment or owner withdrawals, it has not created additional resources. It has used cash that will need to be replaced when the VAT return becomes payable.

This can be particularly deceptive in a growing business.

As sales increase, customer receipts become larger, and the bank balance may rise. At the same time, the future VAT liability may also be increasing. Unless management distinguishes between the two, apparent cash growth can be mistaken for improved financial strength.

I prefer to treat expected VAT as committed cash rather than part of the operating balance. Some businesses do this by transferring an estimated amount into a separate bank account. Others maintain a reliable forecast showing the liability and payment date. The mechanism matters less than the discipline. 

“The business should never discover what it owes only when the VAT return is submitted.”

PAYE and National Insurance Are Already Committed

Payroll creates more than the net wages paid to employees.

A company may deduct income tax, employee National Insurance and other amounts through payroll. It may also incur employer National Insurance, pension contributions and other employment-related liabilities.

Some of those amounts remain in the bank account temporarily, but they are not available for general use.

They are due to HMRC, pension providers or other parties.

Suppose the company’s payroll records show:

• £70,000 of net wages.
• £22,000 of PAYE and National Insurance due to HMRC.
• £5,000 of pension contributions.
• £3,000 of other payroll-related commitments.

Paying £70,000 to employees does not complete the payroll cash requirement. A further £30,000 is still committed.

If management looks at the bank balance immediately after paying the net wages, it may believe the major cash outflow has passed. In reality, a substantial part of the payroll obligation remains outstanding.

This becomes especially dangerous when a business falls into the habit of using PAYE money as temporary working capital. The following month’s receipts are then needed to settle the previous month’s liabilities, while also funding the current payroll.

The business begins operating one step behind. A single late customer payment can then create a crisis because there is no longer any margin for error.

Corporation Tax Can Be Invisible for Months

Corporation tax presents a different challenge because the liability builds as the company earns profit, but the payment is usually made later.

A successful year can therefore leave a business with a strong bank balance and a significant tax commitment that has not yet been paid.

Imagine a company expects to make a taxable profit of £300,000. Subject to the applicable tax rules, reliefs and rates, that profit could create a substantial corporation tax liability.

The cash may remain visible in the bank for months before the payment date.

During that period, the owners might decide to:

• Pay a dividend.
• Purchase new equipment.
• Recruit additional employees.
• Repay borrowing.
• Move to larger premises.
• Use the cash as a deposit for an acquisition.

Each decision may be commercially reasonable. But if management has not reserved for corporation tax, the same money is effectively being allocated twice.

It is being treated as available for investment while also being required for tax.

I prefer to recognise corporation tax as the profit is earned, rather than waiting for the accounts to be completed. The estimate will change as actual results become clearer, but an informed provision is far safer than pretending the liability does not exist until the tax return is prepared.

“A future payment does not become less real because it is several months away.”

The Next Payroll May Already Belong to Your Employees

Payroll is one of the least flexible cash commitments in most businesses.

Employees expect to be paid in full and on time. A failure to do so can immediately damage trust, morale and retention. It can also signal that the business is in serious financial difficulty.

This means that part of today’s bank balance may already be needed for the next payroll run.

Suppose a company has £95,000 in the bank on the tenth day of the month. Its next payroll, including employment taxes and pensions, will require £80,000. Customer receipts of £120,000 are expected before payday.

On the surface, the position may look comfortable.

But what happens if a major customer delays a £60,000 payment? What if an invoice is disputed? What if the receipt arrives two days after payroll rather than two days before it?

The company’s practical cash headroom is much smaller than the banking app suggests.

When assessing available cash, I therefore consider not only amounts that are legally due today but also unavoidable commitments falling due before the next reliable cash inflow.

A payment does not need to be overdue before it becomes relevant to a cash decision.

Supplier Money May Only Be Passing Through the Account

A high bank balance can also result from timing differences between customer receipts and supplier payments.

Suppose a contractor receives £250,000 from a customer for a completed project. The bank balance increases substantially.

However, £170,000 of supplier and subcontractor invoices relating to the project are due over the next three weeks.

The contractor has not suddenly gained £250,000 of spending capacity. Much of the receipt is simply passing through the business on its way to the people who helped deliver the project. If management commits the money elsewhere before paying those suppliers, it creates a future shortage.

The same issue arises when invoices have been received but have not yet reached their payment date. Because the money remains in the bank, it feels available. Commercially, however, it has already been committed.

Delaying supplier payments can temporarily improve the bank balance, but it does not create cash. It transfers the pressure to creditors. 

This can lead to:

• Suppliers placing accounts on hold.
• Loss of early-payment discounts.
• Reduced credit terms.
• Refusal to provide materials for future work.
• Personal guarantees being requested.
• Damage to the business’s reputation.
• Key suppliers prioritising other customers.

Supplier credit is a legitimate part of working-capital management, but it should be agreed and controlled. It should not depend on ignoring payment dates until suppliers begin chasing.

Customer Deposits Can Create the Strongest False Confidence

Customer deposits are particularly misleading because they bring cash into the business before all the related costs have been incurred. Suppose a company receives a £100,000 deposit for a major project. The bank balance improves immediately. But the money has not necessarily been earned, and it certainly is not all profit.

The deposit may be needed to pay for:

• Materials.
• Labour.
• Subcontractors.
• Design work.
• Equipment hire.
• Delivery.
• Installation.
• Rectification work.
• Refunds if the project cannot proceed.

The business has also taken on an obligation to deliver something in return.

If the deposit is used to fund unrelated overheads, previous projects or owner withdrawals, the company may lack the resources needed to complete the work for which the money was received.

This creates a form of hidden borrowing from the customer.

The danger grows when a business repeatedly uses new deposits to complete earlier jobs. The bank account may continue to show activity, but the company is becoming dependent on future sales merely to meet existing obligations.

It is similar to running downhill: the business can continue while new money arrives, but it becomes increasingly difficult to stop without falling over.

I therefore want to understand how much of every deposit is genuinely available after allowing for the full cost of fulfilling the associated commitment.

A deposit improves liquidity. It does not automatically increase wealth.

Loan Proceeds Are Cash, but Loan Repayments Are Commitments

When a business receives a loan, the full amount appears in the bank account.

A £200,000 loan creates £200,000 of visible cash.

It does not create £200,000 of profit, and it does not mean the business is £200,000 better off. The company has received an asset (cash) and taken on a corresponding liability.

That liability will create future interest and capital repayments.

Suppose the business uses the loan to purchase machinery expected to improve productivity. That may be a sound investment. But part of future operational cash flow is now committed to servicing the borrowing.

When I assess available cash, I therefore consider the repayment schedule as well as the current balance.

A company might hold £80,000 in the bank while facing monthly loan and asset-finance payments of £18,000. If operational cash flow is weak, that balance could disappear quickly.

The issue is not whether the business has cash today. It is how much of its future cash generation has already been promised to lenders.

This is also why unused lending facilities should not be confused with business strength. An overdraft or revolving credit facility can provide valuable protection, but using it creates debt, cost and future dependence.

Borrowing increases immediate liquidity. It does not remove the need for the underlying business to generate cash.

Several Commitments Can Fall Due at the Same Time

The greatest pressure usually arises when several individually predictable payments coincide.

Consider a business with £180,000 in the bank. Its directors believe the company has sufficient cash to invest £50,000 in a new system. However, within the next four weeks, the business must pay:

• £35,000 of VAT.
• £28,000 of PAYE and National Insurance.
• £75,000 of payroll.
• £40,000 to suppliers.
• £8,000 of loan repayments.

Those commitments total £186,000.

The company is already £6,000 short before purchasing the system, even though its bank account initially showed £180,000.

Customer receipts may arrive before all the payments fall due, but that introduces another question: how certain are those receipts?

If they are based on invoices that have not yet been approved, customers with a history of paying late or sales that have not yet been completed, they should not be treated with the same confidence as cash already in the account.

Available cash is therefore not a fixed number. It depends on both the commitments the business must meet and the reliability of the receipts expected before those commitments fall due.

A Credit Balance Can Conceal Financial Stress

Another danger is assuming that a positive balance means the business is financially secure.

A company may keep its bank account positive by:

• Delaying supplier payments.
• Using VAT or PAYE money.
• Drawing down loans.
• Receiving deposits for future work.
• Reducing stock purchases.
• Postponing necessary investment.
• Asking owners to inject additional funds.

The bank balance remains above zero, but the underlying pressure continues to build. For example, a company with £50,000 in the bank may also have:

• £90,000 of overdue supplier invoices.
• £25,000 due to HMRC.
• £20,000 of loan repayments approaching.
• A £60,000 payroll requirement.
• Customers owing £200,000, much of it overdue.

The positive balance does not make the business comfortable. It may simply mean that some creditors have not yet been paid. This is why I would never judge cash health from the bank balance alone. I want to see the commitments, overdue amounts, expected receipts and timing of each movement.

The bank balance is one piece of evidence, not the conclusion.

How I Would Calculate a More Meaningful Cash Position

A more useful cash review begins with the current cleared bank balance and then considers what is already committed.

For example:

Cash position	Amount
Current bank balance	£220,000
Less: VAT reserve	(£32,000)
Less: PAYE and pension liabilities	(£24,000)
Less: corporation tax reserve	(£38,000)
Less: next payroll requirement	(£70,000)
Less: suppliers due before expected receipts	(£28,000)
Less: loan repayments due	(£6,000)
Available cash before minimum reserve	£22,000

The business can see £220,000 in the bank, but only £22,000 remains after known commitments.

If management wants to maintain a minimum operating reserve of £50,000, the company does not have surplus cash at all. It is £28,000 below its preferred safety level.

This is a very different conclusion from looking at the banking app and deciding that £220,000 represents spending capacity.

The calculation does not need to be perfect to be useful. Some liabilities will be estimates, and expected customer receipts may alter the timing. What matters is recognising that the visible balance has multiple competing claims against it.

Available Cash Must Include a Safety Margin

Even after deducting known commitments, I would not assume that every remaining pound can safely be spent.

Businesses need headroom for uncertainty.

Customers may pay late. Equipment can fail. A project can overrun. A supplier may request payment earlier than expected. A tax estimate can increase. Sales can temporarily weaken.

A business operating with no cash reserve is relying on every assumption proving correct. That is not cash management. It is hope.

The appropriate reserve will vary according to:

• The predictability of revenue.
• Customer payment behaviour.
• The size and timing of payroll.
• The reliability of forecasts.
• The availability of borrowing facilities.
• Customer concentration.
• Seasonality.
• The level of fixed costs.
• The risk of unexpected expenditure.

A business with contracted monthly income and low fixed costs may require less headroom than a project-based company with volatile receipts and a large weekly payroll.

The objective is not to hoard cash unnecessarily. It is to retain enough flexibility to absorb normal disruption without immediately delaying payments or seeking emergency funding.

The Better Question Is Not “What Is in the Bank?”

When reviewing cash, I would replace one question with a series of more useful ones.

Instead of asking: How much is in the bank?

I would ask:

• How much of the balance is already committed?
• What must be paid before the next reliable customer receipts arrive?
• Which expected receipts are genuinely dependable?
• How much belongs to HMRC, employees, suppliers or customers?
• What loan repayments are approaching?
• What minimum reserve should the business retain?
• How much cash remains after all of those claims are recognised?

These questions convert the bank balance from a number into a decision-making tool. They also reduce the risk of spending the same money twice, once on a new decision and again on the obligation it was already needed to meet.

The standalone lesson is simple:

The bank balance shows what is in the account, not what the business can safely spend.

Visible cash may create comfort. Available cash provides the truth. The difference between the two is where many cash flow problems begin.

Working capital is the money a business needs to finance its everyday operations. It pays for the gap between spending money to deliver a product or service and receiving payment from the customer.

This gap exists because most businesses do not buy, sell, collect and pay for everything on the same day. Materials may be purchased weeks before a product is sold. Employees must be paid before a customer settles an invoice. Stock can sit in a warehouse for months. A project may be substantially complete before the business is entitled to bill for it. The business must finance each of these stages.

When I examine working capital, I am trying to understand three things:

• Where the business’s cash is becoming trapped.
• How long it remains trapped.
• Who is financing the gap while the business waits to recover it.

A profitable business with poor working-capital control can experience constant cash pressure. A business with strong control can often grow further, respond faster and operate with less borrowing.

The Traditional Definition of Working Capital

In accounting terms, working capital is usually calculated as:

Current assets – current liabilities

Current assets are amounts expected to be converted into cash, sold or used within the normal operating cycle. They commonly include:

• Cash.
• Trade debtors.
• Stock.
• Work in progress.
• Other short-term amounts owed to the business.

Current liabilities are amounts expected to be paid within the short term. They commonly include:

• Trade creditors.
• Tax liabilities.
• Accruals.
• Short-term borrowing.
• Other amounts due within the next year.

This calculation provides a broad indication of short-term financial strength, but the total alone does not tell me enough.

Two companies may report identical working capital while facing very different risks.

One may hold most of its current assets as cleared cash. The other may have the same amount tied up in old stock and overdue customer invoices that are becoming difficult to collect. The accounting value may be similar. The practical value is not.

I therefore look beyond the total and examine the main components individually.

Debtors: Money Earned but Not Yet Collected

Debtors (often called trade debtors or accounts receivable) are customers who owe the business money. The business has delivered a product or service and raised an invoice, but the cash has not yet arrived.

Suppose a company invoices £200,000 during the month. Its customers receive 30-day payment terms.

If everyone pays exactly on time, the business may have around £200,000 tied up in debtors at any one point. That is approximately one month’s sales waiting to be converted into cash.

If customers begin paying after 60 days, the debtor balance could rise towards £400,000. The business has not necessarily made any additional sales. It simply has to wait twice as long to receive the money. That extra £200,000 must be financed from somewhere.

The company might use:

• Existing cash reserves.
• An overdraft.
• Invoice finance.
• Extended supplier credit.
• Owner investment.
• Money that should have been reserved for tax.
• Delayed investment or owner withdrawals.

This is why debtor control is much more than a bookkeeping function. Every overdue invoice represents cash the business has earned but cannot yet use. I also distinguish between the value of the debtor ledger and its quality.

A £500,000 debtor balance may look valuable, but I want to know:

• How much is within agreed payment terms?
• How much is overdue?
• Are any invoices disputed?
• Do the customers have the ability to pay?
• Is the supporting documentation complete?
• Is too much owed by one customer?
• How quickly is the balance being collected?
• Is any of it unlikely to be recovered?

A debtor only supports the business when it turns into cash.

Debtor Days Show How Long the Business Waits

Debtor days provide a useful measure of the average time customers take to pay.

A simplified calculation is: Trade debtors ÷ annual credit sales × 365

If a business has £300,000 of trade debtors and annual credit sales of £3 million, its approximate debtor period is: 

£300,000 ÷ £3,000,000 × 365 = 36.5 days

The exact calculation can be affected by VAT, seasonality and changes in revenue, but it provides a useful indicator. More important than the isolated number is the trend.

If debtor days rise from 36 to 50, the business is taking two weeks longer to turn its sales into cash.

On annual credit sales of £3 million, those additional 14 days represent approximately £115,000 more cash tied up in customers:

£3,000,000 ÷ 365 × 14 = approximately £115,000

The profit margin has not necessarily changed. But the business now needs to find another £115,000 to support the same level of sales.

“A small change in collection time can therefore create a significant funding requirement.”

Stock: Cash Waiting to Become a Sale

Stock includes the goods and materials a business holds for sale or intends to use in production.

It might consist of:

• Raw materials.
• Components.
• Finished goods.
• Consumables.
• Spare parts.
• Products purchased for resale.

Stock is necessary in many businesses. Without sufficient stock, the company may be unable to satisfy customers, maintain production or respond quickly to demand.

But stock also absorbs cash.

The business pays a supplier and receives goods rather than money. The cash cannot return to the bank until the stock is sold and the customer pays. Suppose a wholesaler purchases £250,000 of stock. 

• If it sells the stock within 30 days and collects from customers shortly afterwards, the cash turns over relatively quickly.
• If the stock remains unsold for six months, the same £250,000 is unavailable for payroll, tax, marketing, investment or other purchases throughout that period.

The stock may still appear as an asset in the accounts, but that does not mean it is financially harmless. Some stock may also:

• Become damaged.
• Go out of date.
• Become technically obsolete.
• Fall out of fashion.
• Require discounting.
• Be held for products customers no longer want.
• Exist in the records but not in the warehouse.

I therefore ask not only how much stock the business holds, but why it holds it and how quickly it moves. Too little stock can reduce sales and damage service. Too much stock can make the business appear asset-rich while leaving it cash-poor.

Good stock management is a balance between operational resilience and financial efficiency.

Stock Days Measure How Long Cash Remains on the Shelf

Stock days estimate how long stock is held before being sold or used.

A common calculation is: Average stock ÷ annual cost of sales × 365

Suppose a business holds average stock of £400,000 and has annual cost of sales of £2 million:

£400,000 ÷ £2,000,000 × 365 = 73 days

This suggests that the company holds approximately 73 days of stock.

If it can reduce this to 55 days without damaging sales or operations, it could release approximately £99,000 of cash:

£2,000,000 ÷ 365 × 18 days = approximately £99,000

That cash has not come from a new loan or additional sale. It has been released from the company’s existing operations.

However, I would not pursue a lower stock figure blindly. If reducing stock causes missed orders, production delays or expensive emergency purchases, the apparent cash benefit could destroy value elsewhere.

“The objective is not minimum stock. It is the right stock, in the right quantity, moving at the right speed.”

Work in Progress: Cash Tied Up in Unfinished or Unbilled Work

Work in progress is especially important in construction, manufacturing, engineering, professional services and other project-based businesses. It represents work that has begun but has not yet reached the point at which it is completed, sold or fully invoiced.

The business may already have incurred:

• Labour costs.
• Subcontractor charges.
• Materials.
• Travel and accommodation.
• Equipment hire.
• Design costs.
• Site costs.
• Project overheads.

Until the work is invoiced and collected, the business is financing those costs.

Suppose a contractor spends £40,000 each month on a project but is only permitted to invoice when it reaches a milestone at the end of month three.

By that point, it has invested £120,000 in the project.

If the customer then has 30-day payment terms, the contractor may need to finance another month before receiving the money. The project could require £160,000 of working capital before the first major receipt arrives.

If the milestone is delayed, the invoice requires approval, or the customer disputes part of the work, the cash remains trapped for longer.

Work in progress can become particularly dangerous when it is poorly measured. Management may believe projects are progressing normally while costs accumulate without a clear route to invoicing.

I want project reporting to show:

• Costs incurred to date.
• Work completed.
• Amounts invoiced.
• Amounts collected.
• Work not yet invoiced.
• The next billing milestone.
• Expected approval and payment dates.
• Remaining cost to complete.
• Any overruns or disputes.

Work in progress is not merely an accounting adjustment. It is money the business has already spent and is trying to recover.

Creditors: Suppliers Helping to Finance the Business

Creditors, often called trade creditors or accounts payable, are suppliers the business owes money to.

Supplier credit can help finance the working-capital cycle.

If a supplier provides materials today but allows the business 30 days to pay, the company does not have to fund the purchase immediately. It has time to use the materials, complete the work or potentially collect from its own customer before paying the supplier.

Suppose a business purchases £100,000 of materials on 60-day terms and sells the completed product for cash within 30 days.

The customer’s money arrives before the supplier needs to be paid. The supplier has effectively helped finance the operating cycle. This is one reason some businesses can grow with relatively little external funding.

But supplier credit is not free money.

The business still owes the amount, and its ability to use that credit depends on maintaining trust and paying according to the agreed terms.

Delaying suppliers beyond their due dates may temporarily improve the bank balance, but it can create serious consequences:

• Accounts may be placed on hold.
• Deliveries may stop.
• Credit limits may be reduced.
• The business may lose negotiated discounts.
• Suppliers may demand payment in advance.
• Key commercial relationships may be damaged.
• Future projects may become harder to deliver.

There is an important difference between using agreed supplier terms and failing to pay suppliers because the business does not have the cash. The first is working-capital management. The second is financial distress.

Creditor Days Show How Long the Business Takes to Pay

Creditor days estimate the average time the business takes to pay its suppliers.

A simplified calculation is: Trade creditors ÷ annual credit purchases × 365

If trade creditors are £250,000 and annual credit purchases are £2.5 million:

£250,000 ÷ £2,500,000 × 365 = 36.5 days

As with debtor and stock days, the trend matters.

An increase in creditor days may indicate that the business has negotiated better payment terms. That could be a positive improvement. But it may also indicate that the company is delaying suppliers because it lacks cash. The same number can tell two very different stories.

I would therefore want to know whether:

• Longer terms have been formally agreed.
• Supplier invoices are genuinely disputed.
• The business is paying strategically or merely reacting to pressure.
• Essential suppliers are being protected.
• Overdue balances are increasing.
• Credit limits remain adequate.
• Suppliers are threatening to suspend service.

Creditor days should be interpreted alongside the payment record and supplier relationships. not celebrated simply because the number has increased.

The Working-Capital Cycle

The working-capital cycle describes the journey cash takes through the business.

For a product-based company, the cycle might be:

1. Cash is paid to a supplier.
2. Materials or stock are received.
3. Stock is held or converted into a finished product.
4. The product is sold.
5. The customer is invoiced.
6. The business waits for payment.
7. Cash returns to the bank.

For a project-based service business, the cycle might be:

1. Employees and subcontractors begin work.
2. Materials and site costs are incurred.
3. Work in progress builds.
4. A contractual milestone is reached.
5. The customer approves the work.
6. An invoice is raised.
7. The customer pays.
8. Cash returns to the business.

The cycle begins when the business commits cash and ends when it recovers that cash from the customer. The longer the cycle, the more working capital the business requires. The amount of cash tied up is affected by three main time periods:

• How long stock or work in progress is held.
• How long customers take to pay.
• How long the business has before paying suppliers.

A simplified cash conversion cycle can be expressed as:

Stock or work-in-progress days + debtor days – creditor days

Suppose a manufacturer holds stock for 50 days, waits 45 days for customers to pay and pays suppliers after 30 days:

50 + 45 – 30 = 65 days

The business must finance approximately 65 days of its operating cycle.

If annual operating costs subject to that cycle are £3.65 million, the average daily cost is approximately £10,000.

A 65-day cycle could therefore represent around £650,000 of cash tied up in operations.

That is why apparently modest changes in timing matter so much. Reducing the cycle by ten days could potentially release around £100,000 of cash.

A Simple Working-Capital Scenario

Consider a contractor that wins a project for £120,000 plus VAT. The direct cost of delivering the work is expected to be £80,000, creating a gross profit of £40,000 before overheads.

The project takes two months to complete. During the first month, the contractor pays:

• £25,000 to employees and subcontractors.
• £20,000 for materials.
• £5,000 for equipment hire and other project costs.

The first month therefore creates a £50,000 cash outflow. During the second month, the contractor pays:

• £20,000 to employees and subcontractors.
• £8,000 for additional materials.
• £2,000 for other costs.

A further £30,000 leaves the business. By completion, the contractor has spent the full £80,000 cost of delivering the project.

The contract allows the company to invoice only on completion. The customer takes one week to approve the work, after which the invoice is raised on 30-day terms. The customer then pays ten days late.

The timing looks like this:

Stage	Cash movement	Cumulative cash position
Month one project costs	(£50,000)	(£50,000)
Month two project costs	(£30,000)	(£80,000)
Approval and payment period	£0	(£80,000)
Customer payment received	£120,000	£40,000

The project ultimately produces £40,000 of gross profit before overheads.

But the contractor must finance a maximum cash requirement of £80,000 and wait beyond completion before recovering it.

“The project is profitable, but it is not self-funding.”

If the contractor wins four similar projects at the same time, it could need £320,000 of working capital. That is the risk growth creates. The business may have £480,000 of future revenue and £160,000 of expected gross profit, yet still be unable to finance delivery.

A strong order book does not pay for the work required to complete it.

Better Payment Terms Can Transform the Same Project

Now consider the same £120,000 contract with a different payment structure:

• A 25% deposit when the contract is signed.
• A 40% stage payment at the end of month one.
• The remaining 35% invoiced on completion.

The business receives £30,000 before work begins.

At the end of month one, it invoices £48,000. If that invoice is paid promptly, the business has received £78,000 by the time most of the costs have been incurred.

The final £42,000 becomes payable on completion.

The total price and expected profit have not changed. What has changed is the amount of cash the contractor must provide and the length of time it remains exposed.

The customer is now helping to finance the work rather than expecting the contractor to fund the entire project. This illustrates an important principle:

“Payment terms are part of the commercial value of a sale.”

Two contracts with the same price and margin can have entirely different cash consequences.

A slightly lower-margin contract with a deposit and stage payments may be financially stronger than a higher-margin contract that requires the supplier to finance every cost for several months.

Cash Conversion Measures How Efficiently Profit Becomes Cash

Cash conversion describes how effectively a business turns its reported profit or trading activity into actual cash.

A business with strong cash conversion collects customers promptly, controls stock and work in progress, invoices without delay and uses supplier terms appropriately.

A business with weak cash conversion may report profit while continually absorbing cash.

A simplified cash conversion measure can compare operating cash generated with operating profit:

Operating cash generated ÷ operating profit × 100

If a business reports £500,000 of operating profit and generates £450,000 of operating cash, its cash conversion is approximately 90%.

If it reports the same £500,000 profit but generates only £100,000 of cash, conversion is just 20%.

That does not automatically mean the second business is failing. It may be investing in stock or supporting a temporary period of growth.

But it tells me that £400,000 of the reported profit has not yet appeared as operating cash. I need to understand where it has gone.

Possible explanations include:

• Debtors have increased.
• Stock has increased.
• Work in progress has increased.
• Suppliers have been paid more quickly.
• Customer deposits have reduced.
• Previously delayed liabilities have now been settled.
• Some reported income has not yet been collected.

Cash conversion is most useful as a trend rather than a one-off percentage.

A single weak period may have a reasonable explanation. Repeatedly weak conversion suggests that the business is struggling to turn its accounting performance into usable cash.

Negative Working Capital Is Not Always Bad

It is easy to assume that every business should hold large positive working capital. That is not necessarily true. Some business models collect cash from customers before paying suppliers. A supermarket, for example, may sell goods to customers immediately while receiving credit terms from its suppliers. A subscription business may receive annual payment in advance before delivering the service over the following year.

These businesses can operate with low or even negative working capital because customers and suppliers help finance the operating cycle.

That can be a significant commercial advantage.

However, the model depends on the cash timing remaining favourable. If customer behaviour changes, supplier terms shorten or advance receipts are spent before the related obligations are fulfilled, the apparent advantage can quickly become a risk.

Negative working capital can indicate an efficient operating model, or a business that is failing to pay its liabilities.

Once again, the number does not tell the entire story. I need to understand why it exists.

Working Capital Determines How Much Growth the Business Can Afford

A business does not grow only according to the amount of work it can win. It also grows according to the amount of work it can finance.

Suppose each additional £1 of monthly revenue requires:

• 40 pence of stock or project costs before invoicing.
• 30 pence of labour and overhead before collection.
• A 60-day wait for customer payment.
• Only 30 days of supplier credit.

Rapid sales growth will increase the cash tied up in the cycle.

Unless margins, deposits, payment terms or available funding improve, the company may eventually reach a point where it cannot afford to accept more profitable work.

That is why I see working-capital capacity as part of business capacity.

A company may have the people, customers and technical ability to double its revenue. But if it cannot finance the additional debtors, stock and work in progress, the growth plan is incomplete.

How a Business Can Improve Working Capital

Improving working capital does not always require dramatic cost cutting or new borrowing. The business can often release cash by improving the speed and discipline of its existing processes. Practical actions include:

• Requesting customer deposits.
• Using stage or milestone billing.
• Raising invoices immediately.
• Making invoice requirements clear before work begins.
• Resolving disputes quickly.
• Following up debts before they become seriously overdue.
• Reviewing customer credit limits.
• Reducing unnecessary stock.
• Identifying slow-moving or obsolete stock.
• Monitoring unbilled work in progress.
• Shortening project approval processes.
• Negotiating appropriate supplier terms.
• Scheduling payments according to agreed dates.
• Matching major purchases to customer demand.
• Pricing contracts to reflect their funding requirement.

Each improvement reduces either the amount of cash entering the cycle or the time it remains trapped.

The greatest working-capital improvements often come from coordination across the business.

Sales agrees the payment terms. Operations controls stock and project delivery. Finance raises invoices and collects debts. Purchasing negotiates supplier terms. Management decides how much cash can be committed.

If each function operates separately, the business can win profitable work with payment terms it cannot afford, purchase stock it does not need or complete work that remains unbilled.

Working capital is therefore not solely the responsibility of the finance team. It is the financial consequence of decisions made throughout the business.

The Working-Capital Questions I Would Ask

To understand a company’s position, I would ask:

• How long does it take to invoice after completing the work?
• How quickly do customers actually pay?
• How much of the debtor ledger is overdue or disputed?
• How much stock is held, and how quickly does it move?
• How much cash is tied up in unbilled work in progress?
• When can projects first be invoiced?
• Are supplier terms being used deliberately?
• Are creditors paid according to agreed terms or only when they chase?
• How much additional working capital would further growth require?
• Is the business generating cash from operations or depending on new borrowing?
• Could deposits, staged billing or revised contract terms reduce the funding gap?

These questions tell me far more than the year-end working-capital figure alone.

They reveal how the business converts its activity into cash.

The central lesson is:

“Working capital is the cash trapped between delivering the work and getting paid for it.”

The business may eventually recover that cash and earn a good profit. But until the customer pays, someone must finance the gap.

The better a business controls that cycle, the less cash it needs to tie up, the less dependent it becomes on borrowing and the more safely it can grow.

A cash flow forecast is a forward-looking schedule of the money expected to enter and leave a business over a defined period.

Its purpose is not to predict the future perfectly. No forecast can do that.

Its purpose is to give management enough visibility to identify likely pressure, test its assumptions and make decisions before the business is forced into them.

When I prepare a cash flow forecast, I am trying to answer four practical questions:

1. How much cash will the business have at the beginning of each period?
2. What money is realistically expected to arrive?
3. What payments and commitments must be met?
4. How much cash will remain after those movements?

Those questions may sound simple. The value comes from answering them honestly and placing each receipt and payment in the period when the money is genuinely expected to move.

A forecast based on hopeful payment dates and incomplete costs may look reassuring. It will not protect the business.

A Cash Flow Forecast Is a Timeline

The simplest way to understand a cash flow forecast is as a financial timeline.

It normally divides the future into:

• Days.
• Weeks.
• Months.
• Quarters.

Each column represents a period. Within that period, the forecast records expected cash receipts and payments.

A simplified structure looks like this:

Opening cash + cash receipts − cash payments = closing cash

The closing cash from one period then becomes the opening cash for the next.

For example:

Cash flow	Week 1	Week 2	Week 3
Opening cash	£80,000	£65,000	£92,000
Expected receipts	£50,000	£85,000	£35,000
Expected payments	(£65,000)	(£58,000)	(£75,000)
Closing cash	£65,000	£92,000	£52,000

The calculation is straightforward. The difficult part is deciding which receipts are reliable, when they will arrive and which payments must be included.

That is where a forecast becomes a management tool rather than a mathematical exercise.

Start With Cleared Opening Cash

The forecast begins with the cash genuinely available at the start of the first period.

This may include:

• Cleared balances in business current accounts.
• Cash held in reserve accounts.
• Foreign currency balances converted at an appropriate rate.
• Available cash held in other accounts controlled by the business.

I would normally exclude:

• Customer payments that have not cleared.
• Undrawn loan facilities.
• The unused portion of an overdraft.
• Personal funds the owners might contribute.
• Sales the business hopes to make.
• Deposits that have been promised but not received.

These amounts may become relevant later, but they are not opening cash.

I also want to know whether any bank balance is restricted or reserved for a particular purpose. A deposit held for a customer project, for example, may be visible in the account but needed to deliver that project. It should not automatically be treated as freely available for unrelated expenditure.

Getting the opening position wrong undermines everything that follows.

Forecast Customer Receipts, Not Sales

Customer receipts are usually the largest source of cash entering the forecast.

The key word is receipts.

A sales forecast estimates what the business expects to sell. A cash flow forecast estimates when the money from those sales will actually reach the bank.

I would separate customer receipts into categories such as:

• Payment of existing invoices.
• Deposits.
• Stage payments.
• Contract applications.
• Cash or card sales.
• Subscription income.
• Recurring customer payments.
• Receipts from future forecast sales.

Existing invoices can often be forecast individually, especially in a weekly or 13-week model.

For example:

Customer	Invoice value	Due date	Expected receipt date	Confidence
Customer A	£42,000	8 September	8 September	High
Customer B	£18,000	10 September	24 September	Medium
Customer C	£65,000	15 September	Unknown, invoice disputed	Low

The contractual due date is not always the most realistic expected receipt date.

If Customer B consistently pays two weeks late, I would not place the receipt on its due date simply because that produces a better forecast. I would use its actual payment behaviour unless there is evidence that this invoice will be different.

I would also treat disputed invoices separately. An invoice can be legally due and still be unreliable as a forecast receipt if:

• The customer has queried the work.
• Supporting documentation is missing.
• A purchase order is incorrect.
• The invoice requires certification.
• The customer is experiencing financial difficulty.
• The business has not completed an agreed milestone.

A useful forecast reflects collectability, not just invoicing.

Separate Existing Debtors From Future Sales

I find it helpful to distinguish between receipts from existing invoices and receipts dependent on future trading. Existing debtors relate to work the business has already invoiced. Their timing may still be uncertain, but the sale has occurred.

Receipts from future sales may depend on several events:

1. The work must be won.
2. The product or service must be delivered.
3. The business must be entitled to invoice.
4. The invoice must be approved.
5. The customer must pay.

The further away the receipt is from the current bank account, the greater the uncertainty.

Suppose the sales pipeline includes a potential £200,000 contract. Management expects to win it next month, deliver it during the following two months and receive payment 45 days after completion.

That £200,000 should not appear as next month’s cash receipt.

At best, it may enter the later part of the forecast, supported by assumptions about:

• Probability of winning the contract.
• Start date.
• Delivery timetable.
• Billing milestones.
• Customer approval.
• Payment terms.
• Likely payment behaviour.

A forecast that turns every sales opportunity into immediate cash will almost always overstate the future position.

Include Payroll at the Correct Frequency

Payroll is normally one of the most important and least flexible forecast payments. The forecast should include the full cash requirement, not simply employees’ net pay. Depending on the business, this may cover:

• Weekly wages.
• Monthly salaries.
• Overtime.
• Bonuses and commission.
• Temporary labour.
• Employer National Insurance.
• PAYE and employee National Insurance.
• Workplace pension contributions.
• Benefits and allowances.
• Holiday pay.
• Redundancy or termination costs.

The timing also matters.

A business with weekly-paid operational staff and monthly-paid office staff may have five weekly payroll runs in some months rather than four. If the forecast assumes four payments every month, it will periodically understate cash requirements.

Likewise, seasonal overtime, annual bonuses or planned recruitment should be placed in the period when the cash will be paid.

Suppose a new employee starts in October. The October cash requirement may include more than salary. It might also include:

• Recruitment fees.
• Equipment.
• Software licences.
• Training.
• Travel.
• Employer taxes.
• Pension costs.

The forecast should recognise the complete cash consequence of the decision.

Build Supplier Payments From What Will Actually Be Paid

Supplier payments should ideally begin with:

• Existing unpaid invoices.
• Approved payment runs.
• Contractual payment dates.
• Recurring supplier commitments.
• Expected purchases required to support forecast activity.

A common weakness is to forecast suppliers using a fixed percentage of sales without considering when purchases must be made or paid. That may be acceptable in a high-level long-term model, but it can be dangerous in a short-term forecast.

A project-based business may need to pay for materials several weeks before it can invoice the customer. A wholesaler may place a large seasonal stock order months before the related sales. A manufacturer may need to secure specialist components with a deposit.

I therefore want the supplier forecast to reflect the operational plan.

For existing creditors, I would ask:

• Which invoices are due?
• Which are disputed?
• Which suppliers are essential?
• Are any payment plans in place?
• Have payment dates been formally agreed?
• Will late payment affect future supply?
• Are any suppliers paid by direct debit?
• Are deposits or staged payments required?

For future purchases, I would link payments to expected production, stock or project requirements rather than assuming expenditure will move neatly in line with revenue.

Include VAT and Tax on Their Payment Dates

Tax payments should appear in the periods when they are expected to leave the bank. Depending on the business, the forecast may need to include:

• VAT.
• PAYE and National Insurance.
• Corporation tax.
• Self Assessment payments.
• Construction Industry Scheme deductions.
• Business rates.
• Other industry-specific taxes or levies.

VAT should be forecast using the business’s actual VAT arrangements, including:

• Filing frequency.
• Payment dates.
• Expected output VAT.
• Recoverable input VAT.
• VAT accounting scheme.
• Any existing payment arrangement with HMRC.

I would not simply forecast VAT as 20% of revenue. The payment depends on taxable sales, allowable input VAT, timing and the accounting scheme used.

Corporation tax may occur less frequently, but its size means it can materially change the forecast. If the final liability is not yet known, I would use a reasonable estimate and update it as better information becomes available.

Known uncertainty should be estimated and disclosed. It should not be omitted.

Add Rent and Operating Overheads

The forecast should include the cash cost of running the business. This may cover:

• Rent and service charges.
• Utilities.
• Insurance.
• Software subscriptions.
• Telephone and internet.
• Vehicle costs.
• Professional fees.
• Marketing.
• Travel.
• Repairs and maintenance.
• Training.
• Bank charges.
• Licence and membership renewals.

Some costs are monthly and predictable. Others occur quarterly, annually or irregularly.

Annual renewals are easily missed because they do not appear in every month’s accounts. Insurance, software, accreditations and professional subscriptions can produce a significant concentration of payments.

I would review previous bank transactions and supplier records to identify costs that occur outside the normal monthly cycle.

A forecast built only from monthly averages can hide these peaks.

If annual insurance of £24,000 is paid in November, spreading £2,000 across every month may be appropriate for a profit budget. It is not appropriate for a cash forecast. The bank will experience a £24,000 payment in November.

Show Loan and Finance Repayments in Full

The forecast should include the complete cash payment due to lenders and finance providers. This may include:

• Loan repayments.
• Overdraft interest.
• Asset-finance payments.
• Hire-purchase instalments.
• Invoice-finance charges.
• Credit-card repayments.
• Arrangement fees.
• Final balloon payments.
• Refinancing costs.

I would use the actual repayment schedule wherever possible.

Balloon payments and changes in interest rates deserve particular attention because they can create cash demands that are not obvious from the normal monthly instalment. If a £100,000 balloon payment falls due in nine months, the business needs to plan for it now. Excluding it because it sits outside the immediate quarter does not remove the commitment.

Include Capital Expenditure Separately

Capital expenditure should appear when the business expects to pay for equipment, vehicles, property improvements or other long-term assets.

Examples include:

• Machinery.
• Commercial vehicles.
• Computer equipment.
• Office refurbishment.
• Production systems.
• Warehouse equipment.
• Major software implementation.
• Property deposits or improvements.

The cash flow forecast should show:

• Deposits.
• Stage payments.
• Final balances.
• VAT where relevant.
• Installation costs.
• Training and implementation.
• Any finance received.
• Future finance repayments.

Suppose a machine costs £120,000. The payment terms are:

• 20% deposit on order.
• 50% before delivery.
• 30% after installation.

The cash forecast should show payments of £24,000, £60,000 and £36,000 in the relevant periods, not one £120,000 figure spread evenly across the asset’s useful life. If the purchase will be financed, the forecast should separately show the finance receipt and subsequent repayments.

This makes the funding requirement visible rather than allowing the purchase and borrowing to disappear into a single net figure.

Include Dividends and Owner Drawings

Cash taken by owners must be included in the forecast. For a limited company, this may include:

• Director salaries.
• Dividends.
• Director’s loan withdrawals.
• Pension contributions.
• Personal expenses paid by the company.

For a sole trader or partnership, it may include:

• Regular drawings.
• Tax drawings.
• One-off personal withdrawals.

These payments should reflect what is realistically expected, not what management hopes the business will eventually afford. Dividends require particular care. A company may have sufficient distributable profits to declare a dividend but insufficient cash to pay it safely.

The forecast should therefore test the effect of the proposed payment on:

• Payroll.
• Tax.
• Suppliers.
• Minimum cash reserves.
• Funding covenants.
• Upcoming investment.

If a dividend would cause the business to breach its minimum cash headroom, the timing or amount should be reconsidered. The forecast should inform the decision before the money is withdrawn.

Show New Borrowing as a Separate Receipt

New borrowing should be visible as a financing movement. This could include:

• A term loan.
• An increase in overdraft usage.
• Asset finance.
• Invoice finance.
• A revolving credit facility.
• Owner loans.
• New equity investment.

I would not combine borrowing with customer receipts because the two sources of cash tell different stories. Customer receipts arise from trading. Borrowing provides cash that must normally be repaid.

Keeping financing separate allows management to see:

• Whether the underlying forecast is self-supporting.
• When external funding becomes necessary.
• How much is required.
• What happens after repayments begin.
• Whether the business becomes dependent on repeated borrowing.

It is also useful to show both the position before funding and the position after funding. A forecast may show closing cash of £90,000 after a £150,000 loan receipt. That sounds comfortable.

The more revealing figure is the £60,000 deficit that existed before the loan was introduced.

Calculate Closing Cash for Every Period

Closing cash is the amount expected to remain after all forecast receipts and payments for the period. The calculation is:

Opening cash + total receipts − total payments = closing cash

That closing balance becomes the opening balance for the next period. The progression matters more than the final number alone. A forecast might show:

• £180,000 at the end of month one.
• £140,000 at the end of month two.
• £95,000 at the end of month three.
• £45,000 at the end of month four.
• A £10,000 deficit in month five.

The business has not suddenly developed a problem in month five. The forecast shows that the pressure has been building for several months. Management should investigate the direction of travel:

• Is the balance falling temporarily or continuously?
• Which movements create the decline?
• When is the lowest point?
• Does cash recover without borrowing?
• What assumptions cause the recovery?
• How reliable are those assumptions?

The lowest forecast balance is often more important than the balance at the end of the forecast period.

Set Minimum Cash Headroom

I do not want a forecast merely to tell me whether the bank account remains above zero. A business waiting until forecast cash reaches zero has left itself no room for error. Minimum cash headroom is the amount the business decides it should retain to absorb normal uncertainty and continue operating safely. It may be based on:

• One payroll cycle.
• A number of weeks of fixed costs.
• Essential supplier commitments.
• Tax obligations.
• The reliability of customer receipts.
• Seasonality.
• Available borrowing facilities.
• Customer concentration.
• The consequences of unexpected delays.

Suppose a company sets minimum cash headroom of £75,000. A forecast closing balance of £20,000 is technically positive, but it is £55,000 below the company’s required safety level.

I would show that as a funding or action requirement rather than treating it as an acceptable outcome. The forecast should make the threshold visible:

Forecast cash	Interpretation
Above £75,000	Within agreed headroom
£25,000–£75,000	Increased attention required
£0–£25,000	High risk
Below £0	Forecast funding deficit

The precise values will vary by business. What matters is deciding them before pressure arises.

Include a Contingency

Forecasting without contingency assumes everything will happen exactly as expected. 

It rarely does.

Customer payments may be delayed. Equipment can fail. Project costs can rise. A supplier may demand a deposit. Sales may be lower than forecast. Tax estimates may change. Contingency can be included in several ways:

• A specific cash reserve.
• A percentage allowance against uncertain costs.
• A delay applied to expected receipts.
• A downside scenario.
• An unused borrowing facility.
• A higher minimum cash threshold.

I prefer transparent contingency rather than burying unexplained cushions throughout the forecast. Management should be able to see:

• What uncertainty is being allowed for.
• How the allowance was calculated.
• Whether the contingency is cash or merely undrawn borrowing.
• What happens if it is used.
• What risks remain outside it.

A £100,000 overdraft facility may provide contingency, but it also creates interest, repayment risk and lender dependence when used. It is not equivalent to holding £100,000 of the business’s own cash.

A Cash Flow Forecast Is Not a Budget

A budget sets out what the business intends or expects to achieve over a period. It may include:

• Revenue targets.
• Gross profit.
• Departmental costs.
• Operating profit.
• Capital investment.
• Strategic objectives.

A cash flow forecast focuses on the timing of money. 

Consider a business budgeting £1.2 million of annual revenue. That annual target does not tell management:

• When individual sales will occur.
• When the work will be invoiced.
• When customers will pay.
• When materials and payroll must be funded.
• Whether the resulting cash arrives before major commitments.

The budget provides the commercial plan. The cash flow forecast translates the plan into expected bank movements. Both should be connected, but they are not interchangeable.

A Cash Flow Forecast Is Not a Profit Forecast

A profit forecast estimates the financial performance of the business over a future period. It seeks to show expected:

• Revenue.
• Cost of sales.
• Gross profit.
• Overheads.
• Operating profit.
• Finance costs.
• Tax.
• Net profit.

A cash flow forecast includes transactions that do not affect profit in the same way or at the same time. These can include:

• Loan capital receipts.
• Loan capital repayments.
• Capital expenditure.
• Customer deposits.
• Tax payments.
• Owner investment.
• Dividends.
• Changes in debtors, stock and creditors.

I use the profit forecast to test whether the business plan is commercially viable. I use the cash flow forecast to test whether the business can finance that plan. A plan can be profitable and still be unaffordable.

A Cash Flow Forecast Is Not the Current Bank Balance

The current bank balance describes one point in time. A cash flow forecast shows the expected journey from that point. Suppose two businesses each have £100,000 in the bank.

Business A expects:

• £150,000 of reliable customer receipts.
• £90,000 of payments.
• No significant tax or debt commitments.

Business B expects:

• £40,000 of customer receipts.
• £110,000 of payroll and supplier payments.
• A £35,000 VAT liability.
• A £10,000 loan repayment.

Their current bank balances are identical. Their future positions are not. The banking app cannot show that difference without the information about what happens next.

Worked Example: How £250,000 Becomes a Cash Shortage

Consider a growing project-based business that begins September with £250,000 in the bank. Management feels comfortable. The company has a strong order book and expects to remain profitable. Over the next four months, however, several cash movements overlap:

• A major customer delays a £120,000 payment.
• The business purchases materials for new projects.
• Payroll increases following recruitment.
• A quarterly VAT payment falls due.
• New equipment requires a deposit.
• Existing loan repayments continue.
• A proposed dividend is scheduled for December.

The forecast looks like this:

Cash flow	September	October	November	December
Opening cash	£250,000	£227,000	£148,000	£69,000
Customer receipts	£180,000	£145,000	£205,000	£230,000
New borrowing	£0	£0	£0	£0
Total cash available	£430,000	£372,000	£353,000	£299,000
Payroll and employment costs	(£85,000)	(£92,000)	(£95,000)	(£98,000)
Supplier and project payments	(£90,000)	(£80,000)	(£115,000)	(£105,000)
VAT and tax	(£18,000)	(£35,000)	(£12,000)	(£22,000)
Rent and overheads	(£10,000)	(£10,000)	(£10,000)	(£10,000)
Loan repayments	(£5,000)	(£5,000)	(£5,000)	(£5,000)
Capital expenditure	£0	(£2,000)	(£47,000)	(£15,000)
Dividend	£0	£0	£0	(£30,000)
Total payments	(£203,000)	(£224,000)	(£284,000)	(£285,000)
Closing cash	£227,000	£148,000	£69,000	£14,000

The company does not run out of cash within the four-month forecast. It closes December with £14,000. But suppose management has established minimum cash headroom of £75,000. On that basis, the business is forecast to fall:

• £6,000 below headroom in November.
• £61,000 below headroom in December.

The business therefore has a forecast cash requirement even though its bank balance never becomes negative. The forecast also helps management see that no single payment causes the problem. The pressure results from several events:

• Customer collections arrive later than operational spending.
• Recruitment increases payroll before the growth produces cash.
• VAT and loan commitments continue.
• Capital expenditure is concentrated in November.
• The proposed dividend removes additional headroom in December.

Without the forecast, the £250,000 opening balance could encourage management to approve all these decisions. With the forecast, management has time to consider alternatives.

It could:

• Escalate collection of the delayed customer payment.
• Negotiate staged payments on new projects.
• Reschedule part of the equipment purchase.
• Finance the equipment over its useful life.
• Delay or reduce the dividend.
• Renegotiate supplier payment dates.
• Arrange an appropriate funding facility.
• Phase recruitment in line with confirmed demand.

The forecast does not make the decision. It shows the financial consequences of each option.

Test the Decisions Before Making Them

One of the most valuable uses of a cash flow forecast is scenario testing. Using the worked example, management could compare:

• The existing expected case.
• A case where the delayed customer pays one month later.
• A case where the equipment is financed.
• A case where the dividend is postponed.
• A case where revenue is 10% below forecast.
• A case combining several adverse outcomes.

This allows the business to measure how sensitive its cash position is to each assumption. If moving one customer receipt by seven days creates a funding crisis, the business has very little resilience.

If the company can absorb a sales reduction, a late receipt and an unexpected cost while remaining above minimum headroom, its position is stronger. The objective is not to produce one reassuring number. It is to understand the range of outcomes the business may need to manage.

A Forecast Creates Time—and Time Creates Options

A cash shortage identified today may feel like an emergency. The same shortage identified three months in advance is a management problem with several possible solutions. The business may have time to:

• Improve collections.
• Revise payment terms.
• Rephase expenditure.
• Negotiate with suppliers.
• Change project billing.
• Review drawings or dividends.
• Arrange suitable finance.
• Reduce discretionary costs.
• Delay an investment.
• Build additional cash reserves.

The longer management waits, the fewer options remain.

Emergency borrowing may be more expensive. Suppliers may be less cooperative once payments are overdue. Customers cannot always be persuaded to pay immediately. Equipment orders may be impossible to cancel. Payroll cannot simply be postponed.

That is why the central value of a cash flow forecast is not its ability to predict the exact future bank balance. It is the advance warning it provides.

“A forecast gives management time to act before a cash shortage becomes a crisis.”

There is no single forecasting period that works for every business decision. The right period depends on what management needs to know.

A forecast designed to decide which suppliers can be paid this Friday requires detailed, transaction-level information. A forecast used to evaluate a three-year investment needs broader assumptions about revenue, costs, funding and returns.

I therefore apply a simple principle:

“The closer the forecast period, the greater the level of detail and certainty it should contain.”

Short-term forecasts should be specific. Longer-term forecasts should show direction, capacity and risk.

Daily Visibility During Severe Cash Pressure

Daily cash forecasting is appropriate when the business is experiencing immediate financial pressure. It may be needed when:

• Payroll is approaching.
• The business is close to its overdraft limit.
• Important suppliers are overdue.
• A large customer payment has been delayed.
• HMRC liabilities are due.
• Management must prioritise individual payments.

The forecast should show exact expected receipts and payments for each day. It may also include confidence levels against uncertain customer receipts.

Daily forecasting is intensive, so I would not normally use it indefinitely. Its purpose is to help the business navigate a period in which the timing of a single receipt or payment could materially change what it can afford to do.

Weekly Short-Term Forecasting

A weekly forecast is useful for routine cash control.

It helps management review:

• Customer receipts expected that week.
• Payroll.
• Supplier payment runs.
• Tax commitments.
• Available cash.
• Borrowing headroom.
• Immediate actions required.

This is the level at which I would expect a business to make practical payment and collection decisions.

A weekly forecast provides more control than a monthly model because it does not hide the timing of receipts and payments within one large monthly total.

A business could receive £200,000 on the final day of the month and still be unable to meet a £100,000 payroll two weeks earlier. A monthly forecast might show sufficient cash overall while missing the temporary shortage.

The Rolling 13-Week Cash Flow Forecast

A 13-week forecast provides approximately three months of forward visibility.

This is long enough to identify approaching pressure while remaining close enough for the assumptions to be reasonably specific.

It should include:

• Individual major customer receipts.
• Payroll dates.
• Supplier payment runs.
• VAT and PAYE.
• Loan repayments.
• Planned capital expenditure.
• Known exceptional payments.
• Minimum cash headroom.

The word rolling is important. At the end of each week, the completed week should be replaced with actual results and a new week added to the end. The business therefore maintains a constant 13-week view rather than allowing the forecast to become progressively shorter.

For many businesses, this should be the central short-term cash management tool.

A Rolling 12-Month Forecast

A 12-month forecast answers broader planning questions.

It can help management anticipate:

• Seasonal peaks and troughs.
• Corporation tax.
• Annual renewals.
• Recruitment.
• Equipment purchases.
• Dividends.
• Growth-related working capital.
• Future borrowing requirements.

The assumptions will usually be less precise than those in the 13-week forecast. Customer receipts may be based on sales expectations and typical payment behaviour rather than individual invoices.

The forecast should still be updated regularly. Each month, actual results should replace the forecast figures and another month should be added.

This creates a permanent 12-month view of the expected cash position.

Longer-Term Investment and Funding Forecasts

Major decisions may require forecasts covering several years. Examples include:

• Purchasing machinery.
• Opening a new location.
• Launching a new division.
• Acquiring another business.
• Taking on long-term borrowing.
• Financing a large rental or infrastructure project.

These forecasts are not intended to predict the bank balance on a particular day three years from now. Their purpose is to test:

• The total investment required.
• When the investment becomes cash-positive.
• Maximum funding exposure.
• Interest and repayment commitments.
• Expected returns.
• Downside scenarios.
• Whether the business can support the decision.

The further the forecast looks into the future, the more management should concentrate on assumptions, ranges and scenarios rather than false precision.

Use Different Horizons Together

The forecasting periods should complement one another:

• Daily: What can we safely pay today?
• Weekly: What action is required during the next few weeks?
• 13 weeks: Where is short-term pressure developing?
• 12 months: What seasonal, tax and strategic commitments are approaching?
• Longer term: Can the business afford a major investment or funding decision?

A long-term forecast without short-term control may identify future growth while missing next month’s payroll pressure.

A short-term forecast without longer-term visibility may keep the business operating this week while allowing a predictable tax or funding requirement to remain hidden.

Businesses need detailed short-term control and broader long-term visibility.

A cash flow forecast can provide valuable advance warning, but only if its assumptions reflect how the business actually operates. The spreadsheet itself is rarely the problem. The formulas may work perfectly while the forecast produces a completely misleading answer.

Most cash flow forecasts fail because the information entered into them is incomplete, unrealistic or out of date.

A forecast that shows the answer management wants to see may feel reassuring. It can also be more dangerous than having no forecast at all, because it creates confidence without providing protection.

When I review a cash flow forecast, I therefore spend less time admiring the final bank balance and more time challenging the assumptions that produced it.

Treating Invoice Dates as Receipt Dates

One of the most common errors is placing sales invoices into the cash flow forecast on the date they are raised. If the business invoices a customer for £50,000 in September, that does not necessarily mean £50,000 will enter the bank during September. The customer may have:

• 30-day payment terms.
• 60-day payment terms.
• A monthly payment run.
• An approval or certification process.
• A history of paying late.
• A dispute over part of the invoice.

The cash receipt should be forecast on the date it is realistically expected, not the invoice date.

Suppose a business raises a £100,000 invoice on 30 September. The customer has 30-day terms but only processes supplier payments on the final Friday of each month. Even if the invoice is approved on time, the money may not arrive until late November.

Placing it in September makes the forecast stronger by £100,000 at precisely the point when the business is still waiting for the cash.

Assuming Every Customer Pays on Time

Even when payment terms are included, forecasts often assume customers will follow them exactly. That may be optimistic rather than realistic.

Some customers consistently pay on time. Others normally pay ten days late. Some pay only after being chased. Larger organisations may have complex approval processes that regularly delay payment. I would base short-term receipt dates on evidence such as:

• The customer’s previous payment behaviour.
• Current invoice status.
• Whether a purchase order is correct.
• Whether the work has been approved.
• Whether any dispute exists.
• The customer’s scheduled payment run.
• Recent communication from the customer.

I may forecast a reliable customer payment in the expected case while moving a less dependable receipt into the downside scenario. The objective is not to be unnecessarily pessimistic. It is to recognise that contractual payment terms and actual payment behaviour are not always the same.

Including Unconfirmed Sales

A sales pipeline is not cash. A potential project may look highly likely, but several things must happen before it generates a bank receipt:

1. The customer must place the order.
2. The business must deliver the work.
3. The right to invoice must arise.
4. The invoice must be submitted and approved.
5. The customer must pay.

If any stage is uncertain, the timing of the receipt is also uncertain. Suppose management expects to win a £300,000 contract. It includes the customer’s first payment in the forecast for next month, even though the contract has not been signed.

If the decision is delayed by four weeks, delivery and invoicing also move. The original forecast may then overstate next month’s cash by tens of thousands of pounds. I would separate:

• Contracted revenue.
• Highly probable opportunities.
• Early-stage pipeline.
• Speculative sales.

Only contracted and well-supported receipts should normally enter the short-term expected case. Less certain opportunities belong in an upside scenario until stronger evidence exists.

Forgetting Tax and Irregular Payments

Regular monthly costs are relatively easy to forecast because they appear repeatedly. The payments most likely to be missed are those that happen:

• Quarterly.
• Annually.
• At the end of a project.
• Following a year-end calculation.
• When a contract renews.
• When a legal or regulatory deadline falls due.

These may include:

• VAT.
• Corporation tax.
• PAYE and National Insurance.
• Annual insurance premiums.
• Software renewals.
• Professional subscriptions.
• Business rates.
• Bonuses.
• Final project payments.
• Balloon loan repayments.
• Equipment maintenance.
• Legal and professional fees.

An annual payment does not become less important because it appears only once. If a £60,000 corporation tax payment is due in March, a forecast ending in February will not reveal the requirement. A rolling forecast should bring the payment into view well before it becomes urgent.

I would review previous bank activity, tax records, finance agreements and recurring commitments to identify payments that are easily forgotten.

Ignoring Seasonality

Many businesses do not trade evenly throughout the year. Revenue may increase or fall because of:

• Weather.
• Christmas and other holidays.
• School terms.
• Construction cycles.
• Customer budget periods.
• Annual shutdowns.
• Industry-specific demand.
• The timing of contract renewals.

Costs can also be seasonal.

A retailer may build stock before its busiest period. A contractor may experience winter delays while continuing to pay employees and vehicles. A tourism business may receive most of its income during a few months but incur overhead throughout the year.

Using the same average sales and costs every month can hide the point at which cash pressure is most likely to occur.

Suppose a business generates average monthly revenue of £200,000. That average may appear sufficient to support £170,000 of monthly expenditure. But if actual revenue falls to £100,000 in January and February, the annual average does not help the business meet those months’ commitments.

I would use historical patterns, confirmed work and known operational changes to model the periods separately. Seasonality should also be tested against working capital. A business may need to purchase stock or recruit temporary employees before the seasonal receipts arrive.

Omitting Capital Expenditure

Capital expenditure is frequently missing because it does not appear as a normal monthly operating cost. A business may plan to purchase:

• Vehicles.
• Machinery.
• Computer equipment.
• Property improvements.
• Warehouse equipment.
• A new software system.

The investment may be approved operationally without being fully reflected in the cash forecast.

Suppose management agrees to buy machinery for £150,000. It expects the purchase to be financed, so the forecast includes only the future monthly repayments. However, the finance provider requires:

• A £30,000 deposit.
• VAT to be paid upfront.
• £8,000 of installation costs.
• £5,000 of training and implementation.

The immediate cash requirement may be far greater than management expected. I would forecast the complete transaction:

• Deposit.
• VAT.
• Installation.
• Professional fees.
• Finance receipt.
• Repayments.
• Interest.
• Final balloon payment.

The purchase price alone rarely tells the entire cash story.

Failing to Include Project Delays

Project forecasts often assume that every stage will occur according to the original programme. In practice:

• Work starts late.
• Materials arrive late.
• Weather interrupts delivery.
• The customer changes the scope.
• Approval takes longer than expected.
• Invoicing milestones move.
• Certification is delayed.
• Retentions remain outstanding.

Costs may continue while customer receipts are postponed.

Suppose a contractor expects to complete a milestone in week six and receive £120,000 in week ten. A two-week operational delay may move the customer receipt by more than two weeks if it misses the customer’s approval deadline or payment run.

The money may not arrive until week thirteen or fourteen. Meanwhile, the contractor continues paying labour, subcontractors, equipment hire and overhead.

I would link project receipts to operational milestones rather than simply entering them on the dates shown in the initial sales plan. For major projects, the forecast should be updated when:

• Start dates change.
• Costs exceed estimate.
• Billing milestones move.
• Variations arise.
• Approval is delayed.
• Collection becomes uncertain.

The project programme and cash forecast should tell the same story.

Confusing Optimism With the Expected Case

Business owners are naturally optimistic. They would not invest, recruit or pursue growth if they did not believe the future could be better. Optimism becomes dangerous when the forecast treats the best plausible outcome as the most likely outcome. Examples include assuming:

• Every sales opportunity will convert.
• Every project will start on time.
• Every customer will pay promptly.
• Gross margins will improve immediately.
• No unexpected costs will arise.
• Recruitment will produce instant additional revenue.
• Planned savings will be achieved in full.
• Funding will be approved on the preferred terms.

Each assumption may be possible. The problem arises when all of them must occur simultaneously for the business to remain cash-positive. I would define the expected case using the most realistic assumptions supported by current evidence.

The expected case should not be deliberately gloomy. It should simply be the outcome management reasonably believes is most likely.

Hope can sit in the upside scenario. It should not be disguised as certainty.

Failing to Update Forecasts With Actual Results

A forecast begins losing value as soon as reality starts to differ from it. Suppose the forecast expected:

• Opening cash of £100,000.
• Customer receipts of £80,000.
• Supplier payments of £50,000.
• Closing cash of £130,000.

The actual results were:

• Opening cash of £100,000.
• Customer receipts of £55,000.
• Supplier payments of £62,000.
• Closing cash of £93,000.

The business is £37,000 behind forecast.

Simply carrying the original assumptions forward will compound the error. The next period will begin with £93,000, not £130,000.

Management needs to understand why the variance occurred:

• Were customer payments delayed or lost?
• Did supplier costs exceed forecast?
• Was a payment made earlier than expected?
• Was expenditure omitted?
• Did the sales assumption prove unrealistic?
• Will the difference reverse later or remain permanent?

Updating actual results keeps the forecast connected to reality. It also improves future forecasting because management begins learning which assumptions are consistently unreliable.

Producing the Forecast Once and Never Revisiting It

A forecast prepared for the bank, a funding application or the annual budget often becomes obsolete quickly. Customers pay differently from expected. Projects move. New employees join. Costs change. Tax liabilities are revised. Investments are approved. Commercial priorities shift.

A forecast cannot remain useful if the business changes but the forecast does not.

I view cash flow forecasting as a recurring management process:

1. Update actual cash movements.
2. Reconcile the opening bank position.
3. Revise receipt and payment dates.
4. Add new information.
5. Extend the forecast period.
6. Compare actual results with previous assumptions.
7. Identify actions and responsibilities.

The update does not always require rebuilding the entire model. But it does require management to keep the forecast alive.

Use Expected, Upside and Downside Scenarios

A single forecast creates the impression that only one future exists. In reality, the cash position depends on assumptions that may change. I would normally consider at least three scenarios.

Expected case

The outcome management reasonably considers most likely based on current evidence. It should use realistic:

• Sales conversion.
• Payment behaviour.
• Project timing.
• Margins.
• Costs.
• Funding terms.

Upside case

The outcome if important assumptions perform better than expected. This might include:

• Earlier customer receipts.
• Stronger sales.
• Higher margins.
• Lower project costs.
• Faster project completion.

The upside case can help management understand what becomes possible if performance improves. It should not be used as the main case simply because it gives the best answer.

Downside case

The outcome if credible risks occur. This might include:

• A major customer paying late.
• Revenue falling below plan.
• A project being delayed.
• Gross margin weakening.
• Costs increasing.
• Funding arriving later than expected.
• A tax liability exceeding the estimate.

The downside case is not intended to predict disaster. It tests whether the business can absorb normal setbacks. A business that remains above minimum cash headroom under the downside case has resilience.

A business that needs every assumption to go right has fragility.

Record the Assumptions by Name

A forecast is only as understandable as the assumptions supporting it.

I would avoid vague notes such as:

• Sales increase.
• Customers pay normally.
• Costs reduce.
• New funding received.

Instead, assumptions should be specific:

• Customer A’s £75,000 invoice is expected on 18 October based on written confirmation.
• The new contract begins on 1 November and requires a 20% deposit.
• Materials for Project B will be paid 30 days after delivery.
• Monthly payroll increases by £12,000 from January.
• The proposed £200,000 loan is assumed to complete on 15 December.
• Gross margin is forecast at 35%, compared with 33% during the previous six months.

Named assumptions allow management to:

• Challenge them.
• Assign confidence levels.
• Monitor whether they remain valid.
• Identify which changes affect the cash position.
• Explain the forecast to lenders or investors.

If an assumption cannot be explained, it should not quietly drive a major cash decision.

Review Forecast Versus Actual Results

A forecast-versus-actual review compares what management expected with what really happened. I would review variances in:

• Customer receipts.
• Sales conversion.
• Supplier payments.
• Payroll.
• Tax.
• Capital expenditure.
• Loan movements.
• Closing cash.

But the purpose is not simply to report that the numbers differ. The business should identify whether each variance is:

• A timing variance: The cash movement will occur later or earlier.
• A permanent variance: The amount has genuinely changed.
• An assumption error: The original forecast was unrealistic.
• A control problem: The business failed to invoice, collect or manage expenditure as planned.

That classification matters.

A £50,000 customer receipt delayed by one week may correct itself in the next forecast period. A £50,000 project cost overrun will not. Both create an immediate cash variance, but they require different action.

Give Someone Clear Responsibility

A forecast without an owner tends to become outdated. Responsibility should be clear for:

• Updating the bank balance.
• Reviewing customer receipts.
• Confirming supplier payments.
• Updating payroll.
• Adding tax liabilities.
• Reflecting project changes.
• Revising sales assumptions.
• Producing forecast-versus-actual analysis.
• Escalating future cash pressure.

This does not mean one person must possess all the information.

Sales may confirm the pipeline. Operations may update project timing. Credit control may assess customer receipts. Finance may maintain the model. Directors may approve the assumptions and actions.

But one person should be responsible for bringing the information together and ensuring the forecast is updated on schedule. Otherwise, everyone contributes information when asked, but nobody owns the reliability of the final forecast.

The Forecast Should Produce Action

The final test is whether the forecast changes what the business does. If it identifies a future cash gap, management should agree:

• What is causing it?
• When does it arise?
• How large could it become?
• Which assumption creates the greatest risk?
• Can customer collections be accelerated?
• Can expenditure be rephased?
• Should a dividend or investment be delayed?
• Is external funding required?
• Who is responsible for each action?
• When will the position be reviewed again?

A forecast that is prepared, circulated and filed away has achieved very little.

A useful forecast creates decisions, assigns responsibility and measures whether the resulting actions improve the future position.

“A cash flow forecast is a living management tool, not an annual spreadsheet exercise.”

I define operational cash flow as:

The cash the underlying business generates—or consumes—through its normal trading activity.

It is designed to answer a simple but important question:

“If we remove borrowing, owner investment and exceptional transactions, is the business’s trading activity putting cash into the business or taking cash out?”

This makes operational cash flow a useful measure of the strength of the underlying financial engine.

It should not be confused with the formal cash flow statement prepared for statutory accounts. Here, I am using operational cash flow as a practical management measure that helps directors understand whether everyday trading is generating sufficient cash.

Operational Cash Flow Is Not Profit

Profit measures the financial return earned during a period. Operational cash flow focuses on when the related money is collected and paid.

A business might report strong revenue and profit while customer receipts remain slow. Alternatively, it may collect old customer invoices during a quieter month and generate cash despite reporting lower current profit.

I want to understand both measures:

• Profit tells me whether the business is creating value.
• Operational cash flow tells me whether that value is turning into cash.

A persistent gap between the two requires explanation.

Operational Cash Flow Is Not the Bank Balance

The bank balance includes cash from every source. It may have increased because the business:

• Received a loan.
• Received additional money from its owners.
• Sold a vehicle, property or other asset.
• Delayed paying suppliers.
• Collected a deposit for work it has not yet delivered.

These movements can improve the immediate bank position without improving the underlying operation. Operational cash flow strips away those distractions and concentrates on trading.

Operational Cash Flow Is Not a Full Cash Flow Forecast

A full cash flow forecast projects every expected cash movement, including:

• Trading receipts and payments.
• Tax.
• Capital expenditure.
• Borrowing.
• Loan repayments.
• Dividends.
• Owner investment.
• Exceptional transactions.

Operational cash flow focuses more narrowly on the recurring trading engine. The two measures therefore answer different questions:

• Operational cash flow: Is normal trading generating cash?
• Cash flow forecast: Will the business have enough cash to meet all its commitments?

A business can generate positive operational cash flow and still face a temporary forecast shortage because it is purchasing equipment or repaying debt. It can also show a positive forecast bank balance while generating negative operational cash flow because new borrowing is covering the shortfall.

How the Trading Engine Produces Cash

Operational cash flow connects several business measures.

• Revenue creates the potential for customer receipts, but the timing depends on invoicing and collection.
• Cost of sales creates payments to employees, subcontractors and suppliers required to deliver that revenue.
• Administrative expenses consume the cash needed to maintain the operating structure.
• Debtor days affect how quickly sales turn into customer receipts.
• Creditor days affect how long the business can retain cash before paying suppliers.
• Stock and work in progress affect how much cash must be invested before the business can sell or invoice.

The interaction between these movements determines cash conversion. Strong revenue is not enough if margins are weakening, overheads are rising or an increasing proportion of the resulting cash is trapped in working capital.

A Healthy Bank Balance Can Hide Weak Operations

Consider a business that begins the month with £40,000 in the bank.

During the month:

• Customer receipts total £180,000.
• Supplier, payroll and operating payments total £210,000.
• The business therefore consumes £30,000 through normal trading.
• It also receives a new £150,000 loan.

The bank position becomes:

Cash movement	Amount
Opening bank balance	£40,000
Operational cash outflow	(£30,000)
New loan received	£150,000
Closing bank balance	£160,000

Looking only at the bank balance, the business appears considerably stronger. It has increased from £40,000 to £160,000.

But the underlying operation has consumed £30,000.

The improvement came entirely from borrowing, and that borrowing will create future interest and capital repayments.

If the business continues losing £30,000 of operational cash each month, the new loan provides time but does not provide a solution. After five months, the £150,000 will have been absorbed, and the debt will remain.

This is why I want operational cash flow reported separately from financing movements.

A Practical Operational Cash Flow Diagnostic

I would ask:

• Is operational cash flow consistently positive?
• Is borrowing increasing despite reported profit?
• Are customer receipts keeping pace with revenue?
• Are debtor days increasing?
• Are gross margins weakening?
• Are overheads growing faster than revenue?
• Is stock or work in progress absorbing more cash?
• Is the business taking longer to convert activity into money?
• Would the bank balance still look healthy without new funding?
• Can operational cash flow comfortably support debt repayments and investment?

One negative month may result from normal timing or planned growth. A repeated negative trend is more concerning because it suggests the underlying business is not replenishing the cash it uses.

“Operational cash flow shows whether the underlying trading engine is genuinely generating cash.”

A business can borrow to improve its bank balance, but only its operations can create the recurring cash required to support itself over the long term.