2. 1 IB READ: Chapter 20

3. 2 TargetLearning ObjectiveOutcomeWho?Keywords  Working capital cycle Define working capital and explain the working capital cycle. Define cashflow 4-5 Cash flow Cash flow forecast Liquidity Net cash flow Insolvent Cash inflow Cash outflow  Cash-flow forecasts Prepare a cash-flow forecast from given information. Work out working capital formulae. 5-6  Management of working capital Evaluate strategies for dealing with liquidity problems. 6-7

4. 3 Setting the scene: Find your number. In pairs discus

5. 4 Feedback

6. Working capital is one of the basic metrics used to evaluate a company's financial health. Play Working Capital Here's the formula. Current Assets - Current Liabilities = Working CapitalCurrent AssetsCurrent Liabilities 5

7. Working Capital = CA - CL Current Assets Stocks Debtors - Receivables may refer to the amount due from individuals and companies. Receivables are claims that are expected to be collected in cash Cash Current Liability Overdrafts Creditors 6

8. Working Capital = CA - CL 7 You need working capital to pay for raw materials, day to day running costs and credit offered to customers. You need to have enough cash available to pay your current liability at short notice. You need it to buy stock or extend credit to customers. You don’t want to be left with a liquidity (ability to pay short term debts) Problem Insolvent – when a business cant pay its short term debts.

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10. A good working capital cycle balances incoming and outgoing payments to maximize working capital. Simply put, you need to know you can afford to research, produce, and sell your product 9

11. 10 The working capital ratio is calculated simply by dividing total current assets by total current liabilities. For that reason, it can also be called the current ratio. It is a measure of liquidity, meaning the business’s ability to meet its payment obligations as they fall due. Working capital ratio = current assets / current liabilities In general, the higher the ratio, the greater your flexibility to expand operations. The ideal ratio depends on your industry and particular circumstances. If it is less than 1:1, this usually means you are finding it hard to pay bills. Even when the ratio is higher than 1:1, you may have difficulty, depending on how quickly you can sell inventories and collect accounts receivable. A ratio of 2:1 usually provides a reasonable level of comfort. However, a very high ratio, that is, above 2, indicates that the business has underutilized current assets, that is, it is not investing its assets properly. 1.5 to 2 is best.

12. To calculate the business's operating cycle, find out how long it takes to sell inventories and collect accounts receivable. A business with a long operating cycle should have a higher working capital ratio than one with a shorter cycle. 11

13. Businesses don't go bankrupt because they are not profitable. They go bankrupt because they run out of cash and cannot meet their payment obligations as they come due. Profitable, growing companies can also run out of cash, because they need increasing amounts of working capital to support additional investment in inventories and accounts receivable as they grow. 12

14. Working Capital Here's the formula.Current Assets - Current Liabilities = Working CapitalCurrent AssetsCurrent Liabilities One of the main advantages of looking at the working capital position is being able to foresee any financial difficulties that may arise. Even a business that has billions of dollars in fixed assets will quickly find itself in bankruptcy court if it can't pay its monthly bills. Under the best circumstances, poor working capital leads to financial pressure on a company, increased borrowing, and late payments to creditor - all of which result in a lower credit rating. A lower credit rating means banks charge a higher interest rate, which can cost a corporation a lot of money over time. 13

15. 14 What is ‘cashflow’? The flows of money into and out of the business Money flows in through revenue from sales of service or product Money flows out when wages and expenses are paid or stocks are purchased.

16. Cash Flow Forecast Is a prediction of future flows of cash into and out of a business

17. Inflows & outflows of cash Inflows – Money coming into the business such as owners’ capital, grants, loans & sales revenue. Outflows – Money going out of the business such as buying equipment and stocks, paying expenses, repaying loans, & paying tax.

18. Uses of cash flow Forecast They can be used for: Planning financial activities before problems arise. Predicting cash shortages. They can help identify problems & help find solutions for high out flows of cash/ low inflows of cash.

19. Week 1Week 2Week 3Week 4 INFLOWS Pocket Money Paper Round Total Cash Flow OUTFLOWS Bus Fare School Money CDs Present TOTAL PAYMENTS Opening Balance Closing Balance

20. 19 Inflows Inflows = money received from Customers Local and national government grants Sale of property or equipment Loans

21. 20 Outflows Outflows = money spent by the business on Wages and salaries for staff Raw materials or stock Gas, electricity, water and telephone Rent and business rates Interest on loans VAT Equipment purchases

22. 21 A basic cashflow diagram Jan £ Feb £ Mar £ Apr £ May £ June £ Opening balance 5,000 7,000 4,000 6,00012,00015,000 Add inflows 20,00022,00018,00020,00023,00018,000 Total 25,00029,00022,00026,00035,00033,000 Less outflows 18,00025,00016,00014,00020,00033,000 Closing balance 7,000 4,000 6,00012,00015,000 0

23. 22 The principle of cashflow More money IN than OUT = cashflow positive. BUT high surplus of cash should be avoided in non-interest bearing account) More money OUT than IN = cashflow negative. Can mean shortage of cash to pay bills AIM is to have a positive cashflow or at least a balance.

24. 23 Cashflow forecasts Cashflow forecasts are prepared when: A new product or service is planned New resources (eg new machinery) is being bought A major sales campaign is planned There will be a large increase in existing activities, eg making or selling many more products

25. 24 Activity: Cash flow worksheet Applications

26. 25 Explain the key words Net cash flow

27. 26 Draw a picture that express what a cashflow forecast means to you…

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29. 28 Get an A – Snakes and Ladders style Knowledge and Understanding (define) Application (apply to case study) Analysis (effect on Business – Adv and dis adv) Evaluation (Make a judgement/ recommendation) A Grade

30. 29 Importance of Cash-flow forecast Pg 199

31. 30 Importance of Cashflow

32. 31 Why prepare a cash flow?

33. 32 Why prepare a cash flow?

34. Uses of cash flow Forecast They can be used for: Planning financial activities before problems arise. Predicting cash shortages. They can help identify problems & help find solutions for high out flows of cash/ low inflows of cash.

35. 34 Limitations of a cash flow Unexpected costs – cause inaccuracies Wrong assumptions in estimations Mistakes in preparing revenue and costs forecast or drawn up by inexperienced people. More notes: Pg 199

36. 35 Flow diagram map showing inflow and outflow

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40. 39 Causing Cashflow Notes pg 201

41. 40 Improving Cashflow Pg 202

42. 41 What are the problems for a business with too little cash?

43. 42 What are the SOLUTIONS to these problems?

44. 43 Importance of Cashflow Five bullet points why cashflow is important. Three ways of improving cashflow

45. Working capital is the cash needed to pay for the day to day operations of the business. In other words, working capital is needed by the business to: Pay suppliers and other creditors Pay employees Pay for stocks Allow for customers who are allowed to buy now, but pay later (so-called “trade debtors”) What is crucially important, therefore, is that a business actively manages working capital. It is the timing of cash flows which can be vital to the success, or otherwise, of the business. Just because a business is making a profit does not necessarily mean that there is cash coming into and out of the business. 44

46. There are many advantages to a business that actively manages its cash flow: It knows where its cash is tied up, spotting potential bottlenecks and acting to reduce their impact It can plan ahead with more confidence. Management are in better control of the business and can make informed decisions for future development and expansion It can reduce its dependence on the bank and save interest charges It can identify surpluses which can be invested to earn interest 45

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49. RECAP Why prepare a cash flow? Uses of a cash flow? Limitations of a cashflow How can you tell it is healthy? How can you tell if It’s unhealthy? 48

50. 49 TargetLearning ObjectiveOutcomeWho?Keywords  Working capital cycle Define working capital and explain the working capital cycle. Define cashflow 4-5 Cash flow Cash flow forecast Liquidity Net cash flow Insolvent Cash inflow Cash outflow  Cash-flow forecasts Prepare a cash-flow forecast from given information. Work out working capital formulae. 5-6  Management of working capital Evaluate strategies for dealing with liquidity problems. 6-7