A good year, and an overdraft: Lena's Bakery Ltd made a profit of $60,000 in 2025. Yet on 31 December it had only $25,000 in the bank and the tills, and it owed $15,000 on its overdraft.
Where the cash was: Nothing was wrong with the bread. The cafés and hotels that buy wholesale still owed $40,000, and $15,000 of flour, butter and packaging sat in the Mill Lane store. The profit was real. The cash was somewhere else.
Profit and cash are counted at different moments (3.7.1). A cash flow problem is a shortage of cash to pay the bills as they fall due: the wages every Friday, Valley Grain's flour bill, the rent. A business can be profitable on paper and still unable to pay its staff this week.
Every cash flow problem comes from one of four things going wrong, with the timing or with the size of the money moving in and out.
Cash comes in late
- Customers given long credit, or paying later than agreed (poor credit control)
- Cash sitting in stock that has not yet been sold (too much stock)
Cash comes in smaller
- Fewer customers: a quiet season, a new rival, a downturn
- Customers who borrow to buy spending less when interest rates rise
Cash goes out early
- Suppliers paid before their bills are due
- Staff, stock and equipment paid for long before the sales they make (overtrading)
Cash goes out bigger
- Costs nobody planned for: a broken van, an oven repair
- Prices of supplies, or the interest on an overdraft, going up
The question to ask of any cause: Does it make cash come in later or smaller, or go out sooner or bigger? Say which, and you have explained why it causes a cash flow problem.
A cause that changes none of the four, such as a cost that is paid only next year, is not a cash flow problem this month.
| Cause | Who decides it | At Lena's Bakery Ltd |
|---|---|---|
| Poor credit control | The business | A hotel customer allowed 60 days to pay instead of the end of the month |
| Paying suppliers too soon | The business | Valley Grain's bill paid on delivery instead of 30 days later |
| Too much stock | The business | Three months of flour bought in one delivery |
| Overtrading | The business | A new shop, a new oven and new wholesale customers in the same spring |
| Unexpected costs | Partly: some can be planned for | A van's gearbox fails |
| Seasonal demand | Outside: customers' habits | The quiet weeks after Christmas |
| Rising interest rates, prices or competition | Outside: the bank, suppliers, rivals | The overdraft costs more; flour goes up; Goldcrust opens nearby |
Causes the business chose itself are internal: it can change them. Causes from outside are external: it can only prepare for them. A cause can also be both. A late-paying customer is the customer's doing, but the credit terms that let it happen were the business's.
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The Kingsway Hotel's order: In May 2026 the Kingsway Hotel asks Lena's Bakery Ltd for bread and pastries for its breakfasts: $6,000 a month, the bakery's biggest wholesale order.
One condition: The hotel will pay 60 days after each delivery, not at the end of the month like the cafés. Marco says yes. The sale is good. The cash is two months away.
Selling on credit means handing over the goods now and being paid later. The customers who owe the money are the business's debtors (3.4.2). Deciding how much credit to give, to whom, for how long, and chasing those who pay late is credit control.
Poor credit control is giving too much credit, for too long, or not chasing late payers. The sale is made and the profit is counted, but the cash stays with the customer.
What 60 days does to the bakery's cash
May
The bakery delivers $6,000 of bread and pastries and pays $1,500 of extra wages for the early shift that bakes them. The Kingsway pays nothing yet.
Cash so far: −$1,500.
June
Another delivery and another $1,500 of wages. Valley Grain is now paid for May's ingredients, $1,800 (30% of the sale). Still nothing in.
Cash so far: −$4,800.
July
May's $6,000 finally arrives. $3,300 goes out, as in June.
Cash so far: −$2,100.
August
June's $6,000 arrives. The order has paid back what it borrowed from the bank account, and from here it adds $2,700 a month.
Cash so far: +$600.
On paper
- Each month's order earns $6,000 and costs $3,300.
- So it makes $2,700 a month from the first day.
In the bank
- It takes away $4,800 before it adds anything.
- The costs are paid within 30 days, and the income arrives after 60.
A profitable order, three months short of cash: If the Kingsway paid late, at 90 days, the hole would reach $8,100 before the first payment came in.
Paying suppliers too soon does the same damage from the other side. Valley Grain gives the bakery 30 days to pay for its flour (trade credit, 3.2.2). The bakery's ingredients cost about $40,000 a month. Paid on the day they arrive instead of 30 days later, that money leaves the bank a month before it has to, while the bread it becomes is still being sold.
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A bargain on flour: Valley Grain offers the bakery 10% off if it buys two months of flour and ingredients in one delivery.
On paper
- Flour and ingredients cost about $40,000 a month.
- Two months cost $80,000 − $8,000 = $72,000.
- It saves $8,000.
In the bank
- The $72,000 is paid in one go 30 days later.
- $32,000 more leaves that month than in a usual one.
Stock is cash in another form. Flour in the Mill Lane store has been paid for, but it is cash again only when it has been baked, sold, and paid for by a customer. Too much stock ties up cash that is needed for this week's wages and rent.
Stock can also spoil. Flour goes stale, butter goes off, and Christmas cakes left over in January sell for very little. The bakery held $15,000 of stock at the end of 2025; the two-month delivery would more than double it.
Suppose everything happened in one spring: Lena opens the Station Road shop ($120,000 to fit out) and buys the second deck oven for Mill Lane ($45,000), paying from the bakery's own account. In the same weeks Marco signs the Kingsway and two more hotels, all on 60 days.
Sales will rise. Profit will probably rise. And the bank balance will fall, fast.
This is overtrading: a business growing faster than the cash it has to pay for the growth. Every new sale needs cash first, for flour, staff, equipment and customers' credit, and pays it back later. The day-to-day money that fills that gap is the business's working capital (3.5.2), and growth eats it.
Paid out first
- Station Road fit-out: $120,000
- Second deck oven: $45,000
- New counter staff and extra bakers, paid every Friday
- More flour and packaging every week for three hotels
Paid in later
- Station Road's takings grow slowly, as people find the new shop
- The three hotels pay 60 days after each delivery
- The oven pays for itself over years, not weeks
What the bank sees
- Month after month, more going out than coming in
- The overdraft used up while the order book is full
- A business that could run out of cash in its best year
Overtrading is not a lack of customers: An overtrading business has plenty of customers. Its problem is that each new one needs cash before it brings any in, so the faster it grows, the bigger the gap.
Rising sales are no protection against a cash flow problem here. They are the cause of it.
The quiet weeks after Christmas: December is the bakery's best month: Christmas cakes, party orders, queues at all three shops. Then January comes.
What drops in January
- The shops' takings: people are short of money and eating less cake.
What does not drop
- The wages, the rent and Valley Grain's flour bill.
- And before Easter the bakery must buy in extra flour for the hot cross buns and Easter cakes, weeks before it sells them.
Seasonal demand means sales rise and fall with the time of year. Cash comes in unevenly, but most costs go out every month, so the quiet months can run short even in a good year.
Unexpected costs are bills nobody forecast: a van's gearbox fails, an oven needs a new part, a burst pipe closes a shop for a week. Everyone knows a van will break down some day, but not which month, so the cost is rarely in the plan.
Interest rates rise
- The interest on the overdraft goes up, so cash outflows rise
- Customers who borrow to buy, for a car or a house, buy less, so a seller's cash inflows fall
Sales fall
- A rival opens nearby: if Goldcrust opened on the High Street, Aisha's shop would sell fewer loaves
- A downturn: customers cut back on cakes and lunches first
Supplies cost more
- Valley Grain raises the price of flour after a poor harvest
- Energy prices push up the cost of running the ovens every night
A cash flow forecast (3.7.2) shows these causes as numbers. Here is Marco's forecast for the first three months of 2026, in dollars. It opens with the $25,000 in the bank and the tills at the end of 2025. Figures in brackets are negative.
| All figures in $ | January | February | March |
|---|---|---|---|
| Opening balance | 25,000 | 17,000 | 5,000 |
| Cash inflows | |||
| Cash sales in the shops | 102,000 | 98,000 | 107,000 |
| Cafés and hotels paying | 16,000 | 16,000 | 18,000 |
| Total cash inflows | 118,000 | 114,000 | 125,000 |
| Cash outflows | |||
| Wages | 62,500 | 62,500 | 62,500 |
| Flour and ingredients (Valley Grain) | 40,000 | 40,000 | 40,000 |
| Rent, utilities and other costs | 23,500 | 23,500 | 23,500 |
| Easter flour order (Valley Grain) | 12,000 | ||
| Van insurance for the year | 10,000 | ||
| Total cash outflows | 126,000 | 126,000 | 148,000 |
| Net cash flow | (8,000) | (12,000) | (23,000) |
| Closing balance | 17,000 | 5,000 | (18,000) |
Reading the causes off the forecast
January and February: the quiet season, and slow payers
Shop sales drop after Christmas, and the cafés and hotels pay $16,000 a month instead of about $20,000. Cash out stays at $126,000, so the net cash flow is (8,000), then (12,000).
March: stock built up for a busy season
Valley Grain's $12,000 Easter flour order must be paid before the Easter sales come in.
March: a large one-off bill
The vans' $10,000 yearly insurance. Neither is a surprise, but they land in the same month.
Cash out jumps to $148,000, net cash flow is (23,000), and the balance ends March at (18,000).
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How this comes up: The causes of a cash flow problem are asked about in three ways.
The short question
- It points to a line in the case and asks you to state two possible causes of a cash flow problem, for two marks.
- A few words each; no link to the case is needed.
With a forecast
- The case changes something, often interest rates, and asks you to comment on one possible impact on the business's cash flow, for two.
- One mark for what happens to cash flow, one for why, from the case.
At higher level
- A set of ratios can come with a story: explain two financial challenges, three marks each.
- Marks for naming the challenge, explaining it and showing it in the data.
The two-mark comment pattern
- Say what happens to cash flow, in those words. Cash flow worsens; cash outflows rise; or cash inflows fall.
- Say why, from the case. The overdraft now costs more each month, or customers who borrow to buy will buy less.
- Pick the route that fits the business. A bakery's customers pay for bread from their pockets, so the overdraft route fits. A car dealer's customers often borrow to buy, so the inflow route fits too.
The trap: costs and profit instead of cash flow: 'Costs will rise because the interest on the overdraft goes up' is true, but it never says cash flow. It stops at one mark.
'Cash outflows will rise because the interest on the overdraft goes up' is the same idea in cash flow words, and it is two.
Interest rates are forecast to rise next month. Comment on one possible impact on Lena's Bakery Ltd's cash flow if interest rates rise.
Model answer plan
See the answer broken into clear points, with guidance on how each point earns marks.