This example should enable you to appreciate the need to ensure cash flow from which to pay liabilities as they fall due

Example

You probably face the same cash flow cycle problem yourself. You have various liabilities for rent, council tax, electricity and gas bills and mobile phone payments. You ensure that payments for these liabilities are timed to be paid from your bank after your salary has been paid into your account. Thus, if you are paid on the 25^th of each month, you give your bank permission to pay rent to your landlord on the 28^th of each month and to pay the council tax, electricity and gas direct debits on the 1^st of the following month while the mobile phone bill is paid on the 6^th of the following month. In this way, you are making sure that in your cash flow cycle your bank account receives an inflow of cash from your employer before it flows out to those to whom you owe money.

All business entities face this same problem: they have to keep the cash flowing in before it is paid out to meet liabilities as they become due. When the cash is no longer flowing into an entity, then that entity will quickly find it difficult to survive with no money to pay its liabilities as they become payable.

Further Illustration of the Importance of the Cash Flow Cycle

Other examples of the importance of cash inflows to businesses can be found in Exercises 6.1 in the online workbook along with pages 263-265 (Profit ≠ cash) in Chapter 6 of the textbook and the examples of Start-up.