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 cash 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’?

Current Assets 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 Liabilities 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 loans Creditors Unpaid Tax Unpaid Dividends

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

Purchase of Raw Materials Working Capital Cycle Purchase of Raw Materials Production costs Inventory Sales Debtors Cash How 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?

Predicting the future…… Cash Flow Forecasting

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 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

Cash Inflows Cash Outflows Cash Sales Cash purchases Paying creditors Pay Production Costs Buy Equipment Loan Repayments Tax payments Dividends Loans Owners Capital Grants Debtor payments Rental Income Interest

Cash Flow Vs Profit

Cash flow and profit Are NOT the same!!!! 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 Cash Flow Profit = Revenue – Costs Revenues and costs are recorded at the time of the transaction Net Cash Flow = Cash Inflows – Cash Outflows Inflows and outflows are recorded at the time the cash transfer occurs

Cash Inflows Cash Outflows Imagine a business had the following inflows/outflows in April……………….. Cash Inflows Cash Outflows Cash Sales Cash purchases Paying creditors Pay Production Costs Buy Equipment Loan Repayments Tax payments Dividends Loans Owners Capital Grants Debtor payments Rental Income Interest Look at these cash flows……. Would each of these types of inflow/outflow be included in the profit calculation for 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 £1500 £1200 Grant Total Inflow £2200 Outflows Wages £500 Stocks £400 £600 £900 Electric £200 Total Outflows £1100 £1400 Net Cash flow -£200 £100 Closing Balance £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.

Cash Flow Problems (And how to fix them)

Causes of cash flow problems Overtrading Poor Profitability Overstocking (too much inventory) Poor credit control Unforeseen changes Seasonality 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?

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

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

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

Homework Task – 25 mins Answer all parts of the NPF Question