Unit 3.

7: Cash Flow
➢ The learning outcomes are:

○ The difference between profit and cash flow (AO2)

○ Working capital cycle (AO2, AO4)
○ Cash flow forecasts (AO2, AO4)
○ Liquidity positions (AO2, AO4)
○ The relationship between investment, profit and cash flow
(AO2)
○ Strategies for dealing with cash flow problems (AO3):
Cash flow is the movement of an
organization’s cash inflows (cash
received from the sale of goods and/or
services) and cash outflows (used to
pay for the costs of running the
business).
Importance of Cash (a current asset)

? Business can be profitable but cash deficient

? Business can have high cash inflow but not be
profitable.
? Can be causes by offering credit terms (people buy
now and pay later). Pay by credit or cheque instead
of cash.
Example:
Apple Inc sells $50,000 item to Hurley Inc.

Payment method: Credit, 30 days payment

Revenue of 50,000 immediately BUT Hurley Inc.

has not paid yet.

So Cash does not go up YET!

The difference between profit and cash flow (AO2)

Sales revenue = Price × Quantity

Profit = Sales revenue – Total costs
ATL Activity - Cash flow crises facing businesses in Northern
Ireland
The coronavirus pandemic has affected every industry in every
country around the world. This creates many opportunities for to look
into topical case studies of how different organizations are/aren't
coping with the crisis.
In April 2020, the British Chambers of Commerce states that more
than half of all business in the UK reported cash reserves of three
months or less. Without sufficient cash flow, these businesses will
simply collapse.

Read this article which explains the cash flow crisis facing
businesses in Northern Ireland. Then answer the questions in the
Google form (posted in the GC).
 Working capital (AO2, AO4)

Working capital = Current assets – Current liabilities

The working capital cycle

https://youtu.be/2yrI2sM8LhI
CASH INFLOWS

◼ Money coming in

◼ Comes from sales revenue (customers purchasing

goods), payments from debtors, loans, interest
earned from bank, sales of assets, rent earned from
property owned

◼ Referred to as receipts
 CASH OUTFLOWS

◼ Money going out

◼ Cash leaves a business when the business needs to pay bills

◼ A business needs to itemise their expenses: labour, purchasing

stock, rent, taxes, advertising, interest, etc

◼ Referred to as payments, expenses, outgoings

 NET CASH FLOW
◼ The difference between the inflows and the outflows, in a
particular period of time

◼ A firm wants the net cash flow to be positive, however they

may be able to service temporarily if they experience
negative cash flow

◼ Long term, inflows will need to be greater than outflows

A liquidity problem occurs when there is a lack of cash in the organization because its cash
inflow is less than its cash outflow, i.e. it experiences negative net cash flow.
Key terms
● Cash refers to the money an organization has either in hand and its bank account.
● Current assets are the short-term assets of an organization that can be relatively easy to
convert into cash.
● Current liabilities are the short-term debts of a business, which need to be repaid within
twelve months.
● Debtors are those who owe money to the business as they have bought goods or services on
trade credit.
● Net current assets is the difference between an organization's current assets and its current
liabilities, i.e. Working capital = Current assets – Current liabilities.
● Overdrafts allow customers to temporarily take out more money than is available in their
bank account.
● Short-term loans are advances from a financial lender that need to be repaid within 12
months.
● Stock (or inventory) refers to the volume of goods that a business has available for sale, per
time period.
● Trade creditors are the firm’s suppliers who have yet to be paid.
● Working capital (sometimes referred to as net current assets or circulating capital) refers to
cash or other liquid assets available to an organization for its daily operations.
 Liquidity position (AO2)

Liquidity means the extent to which an organization is able to

convert its assets (items of monetary value owned by the
business) into cash. Liquid assets are those that can be
converted into cash quickly and without negatively impacting
its market value.
Examples of liquid assets include:
● Cash (including deposits at a commercial bank)
● Debtors
● Stock (inventory).
By contrast, illiquid assets are items of
monetary value owned by a business that
cannot be converted into cash as easily or
quickly.

Examples of illiquid assets include:

● Property
● Plant (production facilities)
● Equipment.
The liquidity position of an organization indicates the
extent to which it has sufficient liquidity to continue
its business activities.
Being in a good liquidity position means the business
can avoid bankruptcy (business closure) as the
organization has sufficient liquidity to continue
operating.
A business in a poor liquidity position may struggle to
cover its current liabilities. If the business is not able
to improve its liquidity position, this can eventually
lead to bankruptcy.
The main method of measuring a firm's liquidity position
is liquidity ratio analysis.
Liquidity ratios are financial ratios that examine an
organization’s ability to pay its short-term liabilities and
debts. The IB Business Management syllabus specifies the
following two liquidity ratios:
● Current ratio
● Acid test ratio (also known as the quick ratio).
Business Management Toolkit
Examine how changes in the external environment
can impact an organization's cash flow position.
You might find it useful to refer to BMT 3 - STEEPLE
analysis prior to answering the above question.
Key terms
● Liquidity means the extent to which an organization is able
to convert its assets into cash.
● A liquidity crisis is a situation that arises when a business is
unable to pay its short-term debts. This can eventually lead
to bankruptcy.
● An organization's liquidity position refers to the extent to
which it has sufficient liquidity in order to continue its
business operations.
● A liquidity problem (or cash flow problem) occurs when
there is a lack of cash in the organization because its cash
inflows are less than its cash outflows, i.e., it experiences
negative net cash flow.
Cash flow forecasts (AO2, AO4)

Cash flow forecasting is a

management tool used to monitor an
organization’s cash flows in order to
avoid liquidity problems.
Cash inflows are simply the money going into a business from earnings and
other sources of finance. Examples of cash inflows include:
● Bank loans
● Bank overdrafts
● Business angels
● Capital injections from the owners of the business
● Cash injection from sponsor
● Cash used by customers to pay for the sale of goods and services*
● Interest received on savings in a business bank account
● Crowdfunding sources
● Government grants and/or subsidies
● Payments made to the business from its debtors
● Tax refunds from the government*
Cash outflows are simply the money going out of a business to pay for its
spending. Examples of cash outflows include payments for:
● Advertising costs
● Cost of sales*
● Delivery charges*
● Financial perks (benefits)
● Heating and lighting costs*
● Insurance premiums
● Packaging costs*
● Purchasing of stock (inventory)
● Rent of buildings and premises*
● Staff wages and salaries*
● Telecommunications, including Internet charges
● Utility bills, e.g. gas, water, electricity, and telephone
Key terms
● Cash flow is the movement of money in and out of an organization
for a particular period of time, such as for the next six months.
● Cash flow forecasting is a business management tool used to monitor
an organization’s cash flows so that it can operate without liquidity
problems.
● Cash inflows are the monies going into a business from earnings and
other sources of finance.
● Cash outflows are the monies going out of a business to pay for its
spending.
● A liquidity problem occurs when an business has negative net cash
flow, i.e. a lack of cash as the firm's cash outflows exceed its cash
inflows.
● Net cash flow (NCF) refers to an organization’s estimated difference
between its monthly cash inflows and cash outflows.
The relationship between investment, profit, and cash
flow (AO2)

In Business Management, the term investment refers to the purchase of

fixed assets (such as equipment and machinery), with the intention of
creating a financial return (profit) in the future. It is therefore often
referred to as capital expenditure.
Investment often requires a large initial amount of cash (for purchasing the
fixed assets), so this can have a negative impact on the organization’s net
cash flow. However, in the long run, the business intends for the
investment expenditure to generate a profit for the organization, and
improve its net cash flow.
Despite the risks, investment expenditure is important for an
organization’s survival and sustainability. By contrast, the lack of
investment can negatively affect businesses as they fail to adapt to
changing needs and wants in the marketplace.
True or False Quiz

1. The working capital cycle refers to the time between cash

needed for a firm's costs of production and the cash received
from customers for the purchase of the product.
2. Cash received from interest paid on bank accounts would be
recorded as a cash inflow.
3. Cash from commercial bank loans are categorised as current
assets.
4. Capital expenditures are recorded as a cash outflow.
5. Revenue expenditures are recorded as a cash outflow.
Business Management Toolkit - STEEPLE analysis

Discuss how changes in the external

environment (STEEPLE analysis)
can impact an organization's
investment, profit and cash flow.
Business Management Toolkit - Circular business
models

Examine how the use of circular

business models can impact an
organization's investment, profit
and cash flow.
Causes of cash flow problems:

? Overtrading (trying to expand too quickly)

? Over borrowing
? Offering too much credit terms to customers
? Overstocking (too much inventory not being sold)
? Unforeseen external environment changes
(economic/market/seasonal/social)
Strategies for dealing with cash flow problems
(AO3)
? Reduce credit terms to customers (cash only)
? Increase cash sales/buyers
? Promotion /discounts (especially for cash sales)
? Few Overdrafts
? Sell assets for cash
? Debt factoring
? Sale and leaseback
? Sources of finance (loans/govt grants/investment)
? Reduce expense (cut costs)
? Improve pricing strategies
? New revenue streams (add to product portfolio)
1. Strategies to reduce cash outflows

Possible strategies to reduce cash outflows include:

● Negotiate with creditors and suppliers to improve trade credit terms.
Securing a longer credit period helps to delay cash outflows.
● Pay for purchases of goods and services on trade credit, rather than
using cash.
● Opt for leasing capital equipment instead of purchasing such assets.
Although this reduces the organization’s net assets on its balance
sheet, it can provide much needed liquidity for the firm.
● Reducing stock levels (inventories), as this can reduce cash outflows
needed to pay for purchasing stocks. This is particularly important
for organizations with a long working capital cycle.
2. Strategies to increase cash inflows

Possible strategies to increase cash inflows include:

● Raising prices of the products the business sells that have few substitutes or a
high degree of brand loyalty. Loyal customers are not overly sensitive to higher
prices, so this earns a greater profit margin for the business.
● Reduce prices of the products the business sells that have a high degree of
competition. This can help to attract customers from rival firms.
● Reducing the credit period helps to improve the cash flow cycle, because
customers buying on credit pay within a shorten time period. However, some
customers may be unhappy about having to pay earlier, so may seek alternative
providers that offer better credit terms.
● Encourage debtors to pay their invoices early by offering discounts. This
shortens the working capital cycle.
● Improved marketing strategies to attract customers, raise brand awareness,
boost sales and develop customer loyalty.
● Use a debt factoring service to chase up outstanding debtors.
3. Strategies to seek additional sources of finance
Possible strategies to seek additional sources of finance include:
● Businesses will often rely on bank overdrafts or bank loans as additional
finance when faced with a liquidity problem. These external sources of
finance can help the business during times of negative net cash flow, or
when it experiences a negative closing balance. However, external finance
incurs interest repayments, which can harm cash outflows.
● Secure finance from sponsorships, donations or financial gifts. This can help
to boost cash inflows, thereby improving the cash flow position. However,
these sources of finance are not easily accessible to most businesses.
● Selling shares in a limited liability company in order to raise additional
sources of finance. Whilst this could bring in additional cash, it can be an
expensive operation, and such option is not available to sole traders and
partnerships.
● In the worst-case scenario, an organization could sell its fixed assets to raise
additional finance. For example, the business could sell off its underused or
out-dated assets. In June 2020, British Airways decided to sell some of its
multi-million-dollar art collection in order to raise cash to help it get through
the crisis caused by the coronavirus pandemic.
Key terms
● Bad debts occur when debtors are unable to pay their
outstanding bills. This reduces the cash inflows for the
vendor (seller).
● Cash flow problems are liquidity issues that arise when
an organization has insufficient funds to run its
business, i.e., when its net cash flow is negative.
● Credit control refers to the process of monitoring and
management of debtors, such as ensuring only suitable
customers are given trade credit and that customers do
not exceed the credit period.
Cash Flow Forecast: future prediction of cash
flows (monthly)

We do cash flow forecast to:

Help assess financial health (likelihood of insolvency/liquidation/net cash flow)
Help identify variations in liquidity over time (periods of difficulty)
Help with planning and financial control (mange when cash flow will be positive/negative and
plan payments around that)
It can be compared with actual results which help with future predictions and production
planning
Reasons the cash flow forecast may be wrong
? Poor market research
? Human resources (motivation/skill/effort)
? Technological failure
? Economic changes
? Change in fashion/taste
? Global shocks (resource depletion /war/crisis)
Do we now understand?

? The importance of understanding a business’s cash flow

(+forecasting)
? Causes of cash flow problems
? Method to improve cash flow
? How to present cash flow professionally to the statutory
requirements
? How to read the cash flow forecast and identify strengths and
weaknesses
? Limitations of cash flow forecasting
Complete a 6 month cash flow forecast