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IB BUSINESS MANAGEMENT: 3.7 CASH FLOW Cash is needed to pay for daily costs such as wages and electricity charges. failure to pay suppliers, wages and utility bills may eventually result in a business being declared bankrupt. The term liquidity refers to how easily an asset can be turned into cash. Evidence from around the world has consistently shown that insufficient cash flow is the single largest from of business failure, rather than lack of profitability.
KEY LEARNING OUTCOMES: Explain the relationship between investment, profit and cash flow Define working capital and explain the working capital cycle Prepare a cash flow forecast from given information Evaluate strategies for dealing with liquidity problems
Working capital - definition: The capital needed to pay for raw materials, day-to-day running costs and credit offered to customers. In accounting terms:
CASH FLOW - WORKING CAPITAL Cash is often referred to as the 'lifeblood' of a business. All businesses need finance to pay for everyday expenses such as wages and the purchase of stock. Without sufficient cash flow or working capital a business will be illiquid - unable to pay its immediate or short term debts. Either the business raises finance quickly, such as a bank loan, or it may be forced into liquidation
Working capital = current assets - current liabilities. Liquidity - definition: The ability of a firm to be able to pay its short-term debts.
by its creditors, the firms it owes money to.
Insolvent - definition: When a business cannot meet its shortterm debts.
Working capital = current assets - current liabilities.
WHAT IS WORKING CAPITAL?
WHAT IS CASH FLOW?
WORKING CAPITAL MANAGEMENT
IN-DEPTH EXPLANATION Indepth information about the different problems associated with working capital and different financing options.
There are many different options available to businesses to more effectively manage their working capital requirements.
THE WORKING CAPITAL CYCLE:
WHAT IS FREE CASH FLOW?
Working Capital Cycle - definition: The period of time between spending cash on the production process and receiving cash payments from customers.
Cash flow - definition: The sum of cash payments to a business (inflows) less the sum of cash payments made by it (outflows). Cash inflows - definition: Payments in cash received by a business, such as those from customers (debtors) or from the bank; e.g. receiving a loan.
(/uploads/1/1/7/5/11758934/_______4774362_orig.jpg) The simple working capital cycle
Cash outflows - definition: Payments is cash made by a business, such as those to suppliers and employees.
The longer this cycle takes to complete, the more working capital a business will need.
THE IMPORTANCE OF CASH FLOW
CASH INFLOWS AND OUTFLOWS
Cash is always important - short-term and long-term. Cash flow relates to the timing of payments to workers and suppliers and receipts from customers. if a business does not plan the timing of these payments and receipts carefully, it may run out of cash even though it is operating profitably. If suppliers and creditors are not paid in time, they can force a business into liquidation of its assets if it appears to be insolvent. Note: Cash is not the same as profit. It is very common for profitable businesses to run short of cash. On the other hand, loss-making businesses can have high cash inflows in the short-term. The diagram on the right explains the links between cash inflows - in the form of revenues - and cash outflows - the costs of production. Working capital is what keeps a business solvent.
(/uploads/1/1/7/5/11758934/_______2903984_orig.jpg) A business must maintain cash in hand
CASH FLOW FORECASTING
WHY CASH FLOW MATTERS
Forecasting cash inflows, examples include: 1.
Owner's own capital injections
Bank loan payments
Customers cash purchases
Forecasting cash outflows, examples include: 1.
Lease payment for premises
Annual rent payment
Electricity, water and telephone/internet bills
Labour cost payments
Variable cost payments; e.g. raw materials
AN EXAMPLE CASH FLOW FORECAST
Cash Flow Forecast Worked Example PDF
PREPARING A CASH FLOW FORECAST: MR BURTON EXPLAINS
KEY TERMS: Cash flow forecast: Estimate of the firm's future cash inflows and outflows Net monthly cash flow: Estimated difference between monthly cash inflows and outflows Opening cash balance: Cash held by the business at the start of the month Closing cash balance: Cash held at the end of the month becomes next month's opening balance
CAUSES OF CASH FLOW PROBLEMS:
IMPROVING CASH FLOW
1. Lack of planning 2. Poor credit control 3. Allowing too much credit 4. Expanding too rapidly 5. Unexpected events
CREDIT CONTROL Credit control: Monitoring of debts to ensure that credit periods are not exceeded
BAD DEBTS Bad debts: Unpaid customers' bills that are now very unlikely to ever be paid. (/uploads/1/1/7/5/11758934/_______5521286_orig.jpg)
3.7 CASH FLOW: SUMMARY POWERPOINT NOTES
3.7 CASH FLOW: MR BURTON EXPLAINS
EXAM TIPS! 1.
When answering an exam question about improving cash flow, just writing the firm should "increase sales" will not demonstrate a true understanding of the difference between sales revenue and cash flow.
If you suggest "cutting staff and cheaper materials", this may reduce cash outflows, but what will be the negative impact on output, sales and future cash inflows? This suggestion will nearly always be inappropriate for an examination question about improving cash flow.
PROGRESS CHECK - TEST YOUR UNDERSTANDING BY COMPLETING THE ACTIVITIES BELOW You have below, a range of practice activities, flash cards, exam practice questions and an online interactive self test to ensure you have complete mastery of the IB Business Management requirements for the Finance and Accounts 3.7 Cash Flow topic.
USE THE FLASHCARDS IN ALL THREE STUDY MODES
HABITS OF SUCCESSFUL IB STUDENTS
If you really look closely, most overnight successes took a long time."
-- Steve Jobs
IB BUSINESS MANAGEMENT QUIZZES AND TWO CLASSROOM GAMES Test how well you know the IB Business Management Finance and Accounts - 3.7 Cash Flow topic with the self-assessment tool. Aim for a score of at least 80 per cent.
3.7 Cash Flow A Start quiz
Online Exam Builder part of Easy LMS
Instructions: How To Play Kahoot
3.7 Cash Flow B Start quiz
Online Exam Builder part of Easy LMS
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