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 funds 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’?
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 Assets
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 loansCreditors Unpaid TaxUnpaid DividendsAccrued utilities charges
Current Liabilities
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
Working Capital CyclePurchase
of Raw Materials
Production costs
InventorySales
Debtors
CashHow 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?
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 – 2 minutes
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
Write them on the board
Cash Sales
Loans
Grants
Debtor payments
Owners Capital
Cash purchases
Paying creditors
Pay Production Costs
Buy Equipment
Loan Repayments
Tax payments
Dividends
Rental IncomeInterest
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
Profit = Revenue – Costs
Revenues and costs are recorded at the time of the transaction
Cash Flow
Net Cash Flow = Cash Inflows – Cash Outflows
Inflows and outflows are recorded at the time the cash transfer occurs
Cash Sales
Loans
Grants
Debtor payments
Owners Capital
Cash purchases
Paying creditors
Pay Production Costs
Buy Equipment
Loan Repayments
Tax payments
Dividends
Rental IncomeInterest
Look at these cash flows……. Would each of these types of inflow/outflow be included in the profit calculation for
April?
Imagine a business had the following inflows/outflows in April………………..
Task
Look at the following and decide whether they would immediately affect cash
flow/profit or both…..
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
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 £1000 £1500 £1200 £1200 £1500
Grant £1000
Total Inflow £1000 £1000 £1500 £2200 £1200 £1500
Outflows
Wages £500 £500 £500 £500 £500 £500
Stocks £500 £400 £600 £500 £900 £400
Electric £200 £200
Total Outflows £1200 £900 £1100 £1200 £1400 £900
Net Cash flow -£200 £100 £400 £1000 -£200 £600
Closing Balance -£50 £50 £450 £1450 £1250 £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
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.
Fill in the missing figuresJan Feb March April
Opening Balance
10,000 19,200 21,300 22,800
Inflows
Sales 5,000 6,000 5,000 7,000
Bank Loan 8,000
Total Inflows 13,000 6,000 5,000 7,000
Outflows
Rent and Rates 1,000 1,000 1,000 1,000
Raw Materials 1,500 1,900 1,500 2,000
Wages 1,000 1,000 1,000 1,000
Utilities 300 0 0 300
Total Outflows
3,800 3,900 3,500 4,300
Net Cash Flow 9,200 2,100 1,500 2,700
Closing Balance 19,200 21,300 22,800 25,500
1
2
3
4
5
7 9
8
10
6
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
CASH FLOW PROBLEMS (AND HOW TO FIX THEM)
So…. What could cause a business to have cash flow problems?
Causes of cash flow problems
Overtrading
Poor Profitability
Overstocking(too much inventory)
Poor credit control
Unforeseen changesSeasonality
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?
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
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
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