IB Business and Management (Standard Level) All material taken from the IB Business and Management Textbook: "Business and Management", Paul Hoang, IBID Press, Victoria, 2007

1. Unit 3.3 working CapitalLesson 1: Working capital & cash flowpp. 360-369 IB Business and Management

2. 1. Think about it… “Don’t empty the water jar until the rain falls.” - English proverb What does this mean and how does it pertain to business? …

3. 2. Focus questions 1. What is cash? 2. What is the working capital cycle? 3. How is it possible to measure liquidity? 4. Are there any differences between cash and profit? 5. How can we forecast cash flow and will there be any problems? …

4. 3a. $$$ cash $$$ What do you need cash for? Cash is also the lifeblood of a business. Companies need cash to keep running. What do they need cash for? Cash is: A current asset. How do companies get it? By selling goods or services. Cash can be in hand (at the business) or at the bank. What are two other assets of a company? Stocks and debtors. So, current assets = cash + stocks + debtors. Remember this. …

5. 3b. $$$ cash $$$ Another way to obtain cash, is how easy it is to turn something into cash. This is called liquidity. How liquid are you? Highly liquid assets are those that can be turned into cash quickly and easily without losing its value. For example, money in your bank account vs. raw materials at your warehouse. If your business has a cash flow problem and causes you to have insufficient working capital, this will lead to insolvency. When you do not have enough working capital to meet current liabilities. No money to run the business, you must close it down, and will lead to liquidation of the firm. Liquidation = sell off firm’s assets to repay money owed to the creditors. You do not want to be in this kind of situation. So in order to avoid this we need to look at several things: Working capital cycle Understanding the difference between cash and profit Cash flow forecasts and problems it faces How to manage working capital …

6. 4a. Working capital cycle Working capital is the money available for the daily running of a business. It is also called Net Current Assets. Working capital = Current Assets – Current Liabilities One of the main reasons businesses fail is because of a lack of working capital. Current Assets are: 1. Cash (money on hand or at a bank) 2. Debtors (people who owe YOU money) 3. Stocks/inventories (unsold stocks of raw material) Current Liabilities are: 1. Overdrafts (short-term finance that YOU owe) 2. Creditors (your suppliers who need to be paid) 3. Tax (money to the government) …

7. 4b. Working capital cycle You must consider the time difference between an order being placed and actually receiving the cash once your product has been delivered. This time lag between cash payments for cost of production and receiving cash from the customer is called… Working Capital Cycle. Firms should have enough working capital, but not too much liquidity. Too much liquidity could be viewed as wasteful and could be invested. You could use the money to be more profitable.

8. 5. Difference between cash & profit Cash Profit Cash inflows can come from sales revenues. Can also come from selling off unused assets, too. Bank loans, donations, and grants from governments. You can also have a lot of cash and be unprofitable. How is this possible? Remember cost can get out of control. Profit= Revenue – Cost Once break-even point has been reached, any sales beyond that is a profit. Selling products on credit (you make a profit before you receive the cash). Can be profitable and cash deficient. NOTE: it is important to manage your working capital and cash flow position in order for your company to survive.

9. 6a. Cash Flow forecasts This is a very important financial document you MUST learn how to read and understand. It shows the expected movement of cash into and out of any business in a given time period. It is based on three key concepts…

11. 6c. So why the need for a forecast? Reasons: Banks will require you to have a cash flow forecast before lending you any money. It is a tool to help YOU the manager to identify periods of cash deficiency. Aids in the planning process and gives you better financial control. Used as a guide to achieve your aims and objectives. Used to improve your predictions and future planning and direction for the firm. Let’s take a look at an example of a cash flow forecast…taken from http://wikitextbook.co.uk/images/5/51/Cash_flow_2.jpg Also on pages 366-367 of your text give another example of this. …

12. Opening balance is the amount cash at the start of the trading period. Closing balance is the amount cash at the end of the trading period.

14. Unit 3.3 working CapitalLesson 2: Management of working capitalpp. 370-376 IB Business and Management

15. 1. Focus questions 1. How can managers deal with liquidity issues? 2. What are three major ways to deal with liquidity problems. 3. What are the limitations on cash flow forecasting? …

16. 2. Dealing with liquidity problems Improving your cash flow position of a business requires you to effectively manage the working capital. You must successfully manage its current assets and current liabilities. Three major ways to do this: 1. Seek different sources of finance 2. Improve cash inflows 3. Reduce cash outflows Let’s take a look at each… …

20. 6. How to minimize the risks & impacts of cash flow problems Have a wider customer base. Avoid relying on a few big customers. Ask for part-payment on long term projects. Establish a way to pay large bills in regular installments. Make sure you have quality management systems in place (see Unit 5.4) …

21. 7. Limitations of cash flow forecasts Inaccuracies occur due to a number of internal and external factors: Marketing: poor market research or campaign Human resources: workforce may become less productive Operations management: machine failure or breakdowns Competitors: aggressive companies Changing fashion and tastes: is your product popular this year? Economic changes: see Unit 1.5 External shocks: war, oil crisis, etc. So, there in NO guarantee that your predictions and assumptions made in the cash flow forecast will materialize. A cash flow forecast is a continuous, ongoing process with regular revisions. …

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