Cash flow, profit and liquidity

Answer: Two explained reasons, e.g. (i) it sells on credit, so profit is recorded before the customers pay; (ii) the van was a large one-off cash outflow that does not match the profit in the month it was paid.

1. Reason 1 with mechanism — credit sales: the sale is recorded as revenue, but no cash has arrived yet
2. Reason 2 with mechanism — the van purchase: a large cash payment in a month when profit was modest (or financed from cash reserves)
3. Alternative acceptable reason — building stock: cash is tied up in inventory that has not been sold
4. Each reason needs its own sentence and a consequence for the business

Examiner technique: Profit is a calculation of income less expenses; cash is money in the bank. Any answer that explains one without naming how the timing differs is only half done.

Answer: Depreciation of the delivery van

1. Cash flow records money actually moving
2. Depreciation spreads the cost of an asset over time and involves no transfer of money

• A. Depreciation of the delivery van — Correct: depreciation is an accounting adjustment. No money moves, so it is not a cash flow.
• B. Cash from a bank loan — Money received — a genuine inflow.
• C. Payments received from credit customers — Money arriving late is still money arriving.
• D. Sale of a redundant machine — A one-off asset sale is a cash inflow.

Examiner technique: This is the classic distinction question. If no money changes hands, it belongs in the income statement, not the cash-flow forecast.