IB Business and Management

3.3 Working Capital

Learning Outcomes

• Define Working Capital and explain the Working Capital Cycle

• Prepare a cash-flow forecast from given information

• Evaluate strategies for dealing with liquidity problems

What is Working Capital?

• The funds available for day-to-day operations of an organisation

• It is used as a measure of both a company's efficiency and its short-term financial health

• A firm with insufficient working capital is said to have liquidity problems

Working Capital = Current Assets - Current Liabilities

Working Capital Questions…

• What are the day-to-day running costs of a business likely to be?

• What will happen if a business can’t afford to pay these running costs?

• What is a ‘Current Asset’?• What is a ‘Current Liability’?

A current asset is an asset which can either be converted to cash or used to pay current liabilities within 12 months

What are these assets likely to be?

Current Assets = Cash + Stock + Debtors

Current Assets

Current liabilities are the liabilities (debts) of the business that are to be settled within the fiscal year

Who might a business owe money to?

Likely current Liabilities = Overdrafts Short term loansCreditors Unpaid TaxUnpaid DividendsAccrued utilities charges

Current Liabilities

So why is working capital so important?

Insufficient working capital is a bigger cause of business failure than a lack of profitability

Are there any other benefits of having plenty of working capital available?

Benefits of good working capital management

• Enhanced goodwill• Less reliance on borrowing (less interest to pay)• Easier to obtain finance • Ability to respond to opportunities• Ability to face crises

Working Capital CyclePurchase

of Raw Materials

Production costs

InventorySales

Debtors

CashHow long might each of these stages last?

What would the problems be of a long working capital cycle?

How could businesses reduce the length of their working capital cycle

Which businesses are likely to have long working capital cycles?

CASH FLOW FORECASTINGPredicting the future……

What is Cash?

• Cash includes all the money a business has in coins and notes

• It also includes money which they have in the bank

What is Cash Flow?

Cash Flow is concerned with:

The timings and amounts of cash inflows and cash outflows

Task – 2 minutes

You have 2 minutes to think about where a business might receive money

These are called Cash Inflows/Receipts

You have 2 minutes to think about what a business might need to spend money on

These are called Cash Outflows/Payments

Write them on the board

Cash Sales

Loans

Grants

Debtor payments

Owners Capital

Cash purchases

Paying creditors

Pay Production Costs

Buy Equipment

Loan Repayments

Tax payments

Dividends

Rental IncomeInterest

CASH FLOW VS PROFIT

Cash Flow Vs Profit

• In the long term businesses should be aiming to make a profit…..

• However in the short term having enough cash is more important.

Cash flow and profit Are NOT the same!!!!

Profit

Profit = Revenue – Costs

Revenues and costs are recorded at the time of the transaction

Cash Flow

Net Cash Flow = Cash Inflows – Cash Outflows

Inflows and outflows are recorded at the time the cash transfer occurs

Cash Sales

Loans

Grants

Debtor payments

Owners Capital

Cash purchases

Paying creditors

Pay Production Costs

Buy Equipment

Loan Repayments

Tax payments

Dividends

Rental IncomeInterest

Look at these cash flows……. Would each of these types of inflow/outflow be included in the profit calculation for

April?

Imagine a business had the following inflows/outflows in April………………..

Task

Look at the following and decide whether they would immediately affect cash

flow/profit or both…..

Receiving a bank loan

Cash Flow Profit Both

Making a cash sale

Cash Flow Profit Both

Making a credit sale

Cash Flow Profit Both

Purchasing stock with cash

Cash Flow Profit Both

Paying wages

Cash Flow Profit Both

Receiving a government grant

Cash Flow Profit Both

Buying stock on credit

Cash Flow Profit Both

The value of a car depreciates

Cash Flow Profit Both

A debtor settles his account for goods purchased last month

Cash Flow Profit Both

The business buys a new vehicle by cheque

Cash Flow Profit Both

Tax bill is paid to the government

Cash Flow Profit Both

A building is sold for more than was paid for it

Cash Flow Profit Both

NET CASH FLOW

Net Cash Flow?

• NET CASH FLOW is the difference between the cash coming into and going out of the business and can be POSITIVE or NEGATIVE

• Net Cash Flow = Cash Inflows – Cash Outflows

Positive Net Cash Flow Negative Net Cash Flow

Cash flow forecasts

• A cash flow forecast is a financial document that predicts what the firms inflows and outflows will be over a period of time

Why is it useful for a firm to produce a cash flow forecast?

Why do businesses need to forecast cash flow?

• They may need to produce a cash flow forecast as part of a business plan

• Allows the firm to spot any months when there will be a cash shortage and give them time to take action or plan for this

• Provides targets for the firm….. If real cash flow is different from what is forecasted they need to investigate why

• Can spot any times where there are cash surpluses and decide what to do with these

An Example

Jan Feb Mar Apr May Jun

Open Balance £150 -£50 £50 £450 £1450 £1250

Inflows

Sales £1000 £1000 £1500 £1200 £1200 £1500

Grant £1000

Total Inflow £1000 £1000 £1500 £2200 £1200 £1500

Outflows

Wages £500 £500 £500 £500 £500 £500

Stocks £500 £400 £600 £500 £900 £400

Electric £200 £200

Total Outflows £1200 £900 £1100 £1200 £1400 £900

Net Cash flow -£200 £100 £400 £1000 -£200 £600

Closing Balance -£50 £50 £450 £1450 £1250 £1850

Activity – Ben’s Burger Bar• Using the question sheet and the blank cash flow

sheet attempt fill in the titles for inflows and outgoings on the table

Now try entering the information that you have been given into the cash flow forecast

Total up the Inflows for each month and enter into the Total Inflows cell

Total up the Outflows and enter into the Total Outflows cell

Now Work out the Net Cash flow for each month by subtracting the Total Outgoings from the Total Incomes.

Net Cash flow =Total Income – Total Outgoings

Finally- Now fill in the Closing Balance by adding the Net Cash flow to the Opening Balance.

The Closing Balance becomes the opening balance for the next month.

Fill in the missing figuresJan Feb March April

Opening Balance

10,000 19,200 21,300 22,800

Inflows

Sales 5,000 6,000 5,000 7,000

Bank Loan 8,000

Total Inflows 13,000 6,000 5,000 7,000

Outflows

Rent and Rates 1,000 1,000 1,000 1,000

Raw Materials 1,500 1,900 1,500 2,000

Wages 1,000 1,000 1,000 1,000

Utilities 300 0 0 300

Total Outflows

3,800 3,900 3,500 4,300

Net Cash Flow 9,200 2,100 1,500 2,700

Closing Balance 19,200 21,300 22,800 25,500

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Now for some IB Questions

Warning! Pick a cash flow question with caution!!

Cash flow questions can be time consuming

Usually only 6 marks available to construct a whole cash flow forecast from scratch

Task – 10 mins

• Complete the cash flow forecast for Rizzo Fashions

CASH FLOW PROBLEMS (AND HOW TO FIX THEM)

So…. What could cause a business to have cash flow problems?

Causes of cash flow problems

Overtrading

Poor Profitability

Overstocking(too much inventory)

Poor credit control

Unforeseen changesSeasonality

Lack of planning

Money tied up in fixed

assets

Not keeping enough retained

profit

How could each of these factors lead to cash flow problems?

What could be done to prevent these issues causing a problem?

Task - Pairs

• Evaluating solutions to cash flow problems• Each pair will be given some causes to focus on• Discuss some solutions and fill in the google doc• Share your solutions with the class

Improving Cash flow

• Reducing costs• Increasing selling price• Increasing sales• Increasing retained profits• Renting rather than buying• Borrowing money- arrange an overdraft or

loan• Delay paying bills as long as possible • tighten up on credit given• Debt Factoring• Reducing stock levels

Homework Task – 25 mins

• Answer all parts of the NPF Question