IB Business and Management Accounts and Finance 3.3 Working Capital

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IB Business and Management Accounts and Finance 3.3 Working Capital

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IBBusinessandManagement.com IB Business and Management The IB Diploma Business and Management course delivered IN STYLE, ONLINE.

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z Working capital 3.3

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z cash The lifeblood of business Why??? Money received from sales of goods & services It is a current asset Current assets = cash + stock + debtors Liquidity: How easily an asset can be turned into cash Liquid assets

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z Working capital

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z The working capital cycle Working capital (net current assets) money available for the daily running of a business Current assets – current liabilities the funds that are available for a business to p[ay its immediate costs & expenditure (running costs)

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z Working capital cycle cash Materials & stock production Credit sales

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z The working capital cycle Current assets – current liabilities Current assets: Resources that belong to the business that are intended to be used within the next 12 months Current liabilities: Money that a business owes that needs to be repaid within the next 12 months cash overdrafts creditors debtors stocks tax There is often a delay between paying for costs of producing a good and receiving the actual cash from the sale e.g. a property developer is building a new subdivision Outline her likely working capital difficulties

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z Cash vs. profit They are not the same It’s common for profitable businesses to run out of cash Loss-making businesses can have high cash inflows in the short-term Example: Arlia owns fine foods, a specialist delicatessen. Last months he bought $500 of fresh goods from a supplier who offers her one month’s credit. The goods sold very slowly during the month and she was forced to cut prices several times. Eventually she sold them all for only $300, paid in cash by her customers What was her profit or loss (ignoring all other costs)? A loss of $200 – because even though she has not yet paid for the goods they are still recorded as a cost What was the difference between her cash outflow and inflow? A positive inflow of $300 – because she has not paid the supplier yet. So arlia has a positive cash flow from these goods this month even though she made a loss on them Cash was not the same as profit for this business

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z Cash flow forecasts 5,000 Money in bank at the end of June $5,000 6,000 5,000 6,500 6,800 7,500 9,500 November rental income of $4,000 4,000 2,500 2,200 2,700 2,700 3,000 3,300 Staff wages: $3,500 per month 3,500 3,500 3,500 3,500 3,500 3,500 2,000 2,000 2,000 1,800 1,800 2,200 6,000 5,000 6,500 6,800 11,500 9,500 8,000 7,700 8,200 8,000 8,300 9,000 (2,000) (2,700) (1,700) (1,200) 3,200 500 3,000 3,000 300 300 (1,400) (1,400) (2,600) (2,600) 600 600 1,100 All other costs: $2,000 per month (except Oct & nov @ $1,800; dec @ $2,200) Store sales (cash) Jul: $6,000 Aug: $5,000 sep: $6,500 oct: $6,800 Nov: $7,500 Dec: $9,500 Purchase of new stock to sell Jul: $2,500 Aug: $2,200 sep: $2,700 oct: $2,700 Nov: $3,000 Dec: $3,300 Steps in preparing a cash flow forecast: Step 1: identify cash inflows Step 2: identify cash outflows Step 3: calculate total inflows Step 4: calculate total outflows Step 5: calculate net cash flows Step 6: calculate closing balance Step 7: transfer closing balance to opening balance of following month

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z Cash flow forecasts advantages disadvantages

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z Cash flow forecasts advantages disadvantages

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z Causes of cash flow problems Poor credit control: Keeping track of who has paid and who has not, who is keeping to agreed credit terms, which customers don’t pay on time – inefficiencies here can negatively impact on cash flow Lack of planning: Cash flow forecast greatly help in predicting future cash flow problems for a business. If problems can be predicted then managers can take early action and make interventions Allowing customers too much credit: Businesses often have to offer credit to be competitive. Customers will go for credit terms because it improves their cash flow. A balance needs to be made between how much and how long. Expanding too rapidly: When a business expands rapidly it has to pay for the increased expansion and for increased wages & materials months before it receives cash from additional sales. Unexpected events: Unforeseen increases in costs – a breakdown of a delivery van that needs to be replaced, or a dip in predicted sales income – a competitor reduces prices, can all impact negatively.

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z Cash in hand increases if cash inflows > cash outflows Cash in hand decreases if cash outflows > cash inflows 2 ays to improve cash flow 1. Increase cash inflows 2. Decrease cash inflows

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z 2 Ways to improve cash flow ↓ Cash outflow ↑ Cash inflow overdraft Short-term loan Sale of assets Sale & leaseback Reduce credit terms Debt factoring Delay payments to suppliers Delaying spending on capital equipment Lease equipment ↓Overhead spending that doesn’t ↓output Question 3.3.1, p. 364 Question 3.3.2, p. 365 Question 3.3.3, p. 368 Question 3.3.4, p. 369 Question 3.3.5, p. 373

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