3.

7 Cash Flow

Sources: InThinking
Hoang Page 299 to 314
 Learning Outcomes
• Distinguish between profit and cash flow (AO2).
• Explain/Calculate the working capital cycle (AO2),
(AO4).
• Explain liquidity position (AO2).
• Explain/ Prepare cash flow forecasts (AO2, AO4).
• Explain the relationship between investment,
profit and cash flow (AO2).
• Discuss strategies to deal with cash flow problems
(AO3).
 3.7.1 Cash Flow versus profit
• Cash Flow: movement of an organization’s cash inflows (cash
received from the sale of goods and services) and cash
outflows (used to pay for the costs of running the business).
• Profit: The positive difference between total sales revenue
and total costs of production
• Cash is not the same as profit.
• Cash flow is concerned with the timings and amounts of cash
inflows and cash outflows.
 Task 1:

• What might a business receive money for?

(these are cash inflows)

• What might a business need to spend money

on? (these are cash outflows)

• What is the difference between sales revenues

and cash inflows?
3.7.1 Cash Flow versus profit

Source: Kognity
 3.7.1 Cash Flow versus profit
• Cash Flow is used to measure the financial health of a
business.
• If firm sells in credit, will generate a profit (if price>unit cost
of production) but won’t generate cash in that period.
• Sales revenue ≠ cash inflows
• Sales revenue can be paid either in cash or as by credit.
• Firms need cash to operate and pay employees and suppliers.
• It is possible for businesses to experience negative cash flow
even when they earn a profit.
• It is possible for businesses to have positive cash flow but still
experience a financial loss.
 3.7.1 Cash Flow versus profit
• Profit is typically calculated on an accrual basis
(when revenue or expense actually accrues to the
business) but does not reflect the actual
movement of funds.
• Cash flow reflect the actual movement of funds,
when a business receives payment and makes a
payment
• A timing difference can exist between the accrual
of a revenue or an expense and the actual receipt
of funds
 3.7.1 Cash Flow versus profit
• A firm can be profitable but cash deficient.
• A firm can be cash rich but unprofitable. A
business can make a loss but has plenty of
cash. Reasons:
– Lack of control of costs of production

All business have to manage cash flow and working

capital to survive
 3.7.5.1 Cash Flow
• Cash is the “lifeblood “ of a business
• Every business needs cash to keep functioning
• 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
• Cash is a current asset
 3.7.5 Cash Flow

Net Cash Flow = Total Cash Inflows – Total Cash Outflows

 Which image represents a positive net
3.7.1 Cash Flow cash flow? Which one represents a
negative cash flow?

Source: https://www.slideshare.net/djpatahern/china-as-cash-flow-presentation-teacher
 3.7.2 Working Capital
• Working capital (Net current Assets): The capital
needed to pay for raw materials, day-to-day running
costs and credit offered to customers.

Liquidity : The ability of a firm to be able to pay its

short-term debts.

Insolvent : When a business cannot meet its short-

term debts (current liabilities)
 3.7.2 Working Capital
• Current assets: Resources that belong to the
business and are intented to be used within
the next 12 months
Current assets= cash + stocks +
debtors
• Current liabilities: Money a business owes that
needs to be repaid within next 12 months.
Current liabilities= bank overdrafts + trade
creditors + other short-term loans
 3.7.2 Working Capital
• Insufficient working capital is the single largest
form of business failure, rather than lack of
profitability.
• All business have to manage cash flow and working
capital to survive
 3.7.2 The working capital cycle
Working Capital Cycle refers to the time interval between
cash outflows for costs of production and cash inflows
from customers who receive their finished goods and
services.

Source:Kognity Source:InThinking
 3.7.2 The working capital cycle
• Often there is a delay between paying for costs of producing
a good and receiving the actual cash from the sale.
• For some businesses, the working capital cycle is very short
(quick) as they receive cash immediately from their sales.
• For other businesses, the working capital cycle is much
longer (slow) due to the long production process and/or the
high price of their products.
• That interval between cash payments for costs of
production and cash receipts from customers is known as
the working capital cycle
• Current ratio = current assets / current liabilities
 Key Terms
• Cash
• Current assets
• Current liabilities
• Debtors
• Net current assets: Working capital = Current assets – Current
liabilities.
• Overdrafts
• short-term loans
• Stock (or inventory)
• Trade creditors
• Working capital
 Practice Question 1
• Define the term working capital cycle. [2 marks]
• Explain the importance of working capital to business
organizations. [4 marks]
• Distinguish between current assets and current
liabilities. [4 marks]
 3.7.3 Liquidity position
• Liquidity: 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
– Cash (including deposits at a commercial bank)
– Debtors
– Stock (inventory).
• Illiquid assets are items that cannot be converted into cash as
easily or quickly. Examples:
– Property
– Plant (production facilities)
– Equipment.
 3.7.3 Liquidity position
• Having a good liquidity position means, the business has sufficient
liquidity to continue operating, it can avoid bankruptcy.
• Poor liquidity position: the business may struggle to cover its current
liabilities.
• The liquidity position shows the ability to repay short-term liabilities
without relying on external sources of finance, which could dilute
ownership and control and/or incur debt interest payments.
• A liquidity problem occurs when there is a lack of cash in the
organization because its cash inflow is less than its cash outflow,
(negative net cash flow)
• Liquidity ratios analysis measure firm's liquidity position, the extent to
which an organization can pay off its short-term debts using its current
(liquid) assets:
– Current ratio
– Acid test ratio (also known as the quick ratio)
 Practice Question 2
• 1) Calculate the current ratio if a business has
current assets valued at $25 million and
current liabilities of $15 million, and comment
on its liquidity position.
• 2) Calculate the acid test ratio for a business
that has current assets equal to $18 million,
current liabilities equal to $12 million, and
stock equal to $2 million, and comment on its
liquidity position.
 Key Terms
• Liquidity
• A liquidity crisis
• Liquidity position
• A liquidity problem (or cash flow problem)
 3.7.4 Cash flow forecast
• Cash flow forecasting
and cash flow
statements are often
used to measure the
financial health of a
business.
• A financial document
that predicts what the
business’ inflows and
Source: Kognity, 3.7.3
outflows will be over a
period of time.
3.7.4 Constructing a cash flow forecast
Key Terms
• Cash Flow Forecast: Financial document that shows the expected movement of cash into and
out of a business, per time period.
• Cash Flow Forecasting: Management Tool used to monitor an organization's cash flows.
• Cash Flow: Refers to the movement of money in and out
• Cash inflow is the amount of cash flowing into or earned by the business from sales, debtors
and other non-core activities such as the sale of unused fixed assets or the rental of extra
office space. This is also called receipts.
• Cash outflow is the amount of cash paid out by the business for core operations such as raw
materials, creditors and electricity and other activities such as legal fees.
• Net cash flow (NCF) is the difference between the total cash inflows and cash outflows. It
could be positive or negative, and typically companies aim for a positive net cash outflow
figure. Liquidity problem occurs when a business has a negative net cash flow.
• Net cash flow= Cash inflows – Cash outflows
• Opening balance refers to the amount of cash the firm has in the bank at the beginning of
the month. If a firm is new, then it will not have an opening balance, so it would be zero.
(Same value as the preceding month’s closing balance)
• Closing balance refers to the amount of cash that the company has at the end of the month.
It is the sum of the opening balance and the net cash flow, which then becomes the opening
balance for the next month. This is calculated using the formula:
• Closing balance = opening balance + net cash flow for the month
• Opening balance = Closing Balance in previous month
3.7.4 Constructing a cash flow forecast
Forecasting cash inflows, examples
Forecasting cash outflows, examples
include
• Bank loans
include
• Bank overdrafts • Advertising costs
• Business angels • Cost of sales
• Capital injections from the • Delivery charges
owners of the business • Financial perks (benefits)
• Cash injection from sponsor
• Heating and lighting costs
• Cash received from customers
to pay for the sale of goods and • Insurance premium
services • Packaging costs
• Interest received on savings in a • Purchasing of stock (inventory)
business bank account
• Crowdfunding sources
• Rent of buildings and premises
• Government grants and/or • Staff wages and salaries
subsidies • Telecommunications, including
• Payments made to the business Internet charges
from its debtors
• Utility bills, e.g. gas, water, electricity,
Example 1

Worked example of an abbreviated cash flow forecast (page 303 Hoang textbook)
Sept ($) Oct ($) Nov ($) Dec ($)
Opening balance 1,000 800 1,600 1,900
Inflows
Cash sales 2,000 2,000 3,000 4,000
Total cash inflows 2,000 2,000 3,000 4,000
Outflows
Stock purchases 600 600 900 1,200
Rent 1,000 0 1,000 0
Other costs 600 600 800 1,000
Total cash outflows 2,200 1,200 2,700 2,200
Net cash flow (200) 800 300 1,800
Closing balance 800 1,600 1,900 3,700
 Example 2
Cash flow forecast for Business X, for the first three months of 2022
Complete this All figures in $000 January February March
Opening balance 10
cash flow forecast Cash inflows
Cash sales revenue 200 120 250
Tax refund 0 10 0
Total cash inflows

• There are different Cash outflows

conventions in Rent 20 20 20
preparing cash flow Packaging 5 15 20
forecasts. Salaries and wages 30 45 75
• However, for the Cost of sales 100 80 170
purpose of IB DP Heating and lighting 20 40 65
Business Delivery 15 15 30
Management course, Total cash outflows
students must follow
the prescribed Net cash flow
format as shown on Closing balance
this slide.
 Cash flow forecast for Business X, for the first three months of 2022
All figures in $000 January February March
Opening balance 10 20 (65)
Cash inflows
Cash sales revenue 200 120 250
Tax refund 0 10 0
Total cash inflows 200 130 250

Complete this
Cash outflows
cash flow Rent 20 20 20
forecast - Packaging 5 15 20
Salaries and wages 30 45 75
ANSWER Cost of sales 100 80 170
Heating and lighting 20 40 65
Delivery 15 15 30
Total cash outflows 190 215 380

Net cash flow 10 (85) (130)

Closing balance 20 (65) (195)
 Analysing a cash flow forecast

1. Describe the total cash

inflow trend.
2. Describe the total cash
outflow trend.
3. Describe the net cash
flow trend.
4. Describe the closing
balance trend.
5. What conclusions can
you draw about the
liquidity position of this
company?
3.7.4 Constructing a cash flow forecast

Source: IB Guide
Example 3
• InThinking
 Practice questions InThinking 1
1) Explain two reasons why a new bakery business is likely to face liquidity
problems in its first few months of its operation. [4 marks]
2) The chief accountant of 360 Computers has compiled the following
financial data:
Opening balance = $50,000
Total cash outflows = $120,000, and
Total cash inflows = $110,000.
Calculate the closing balance for 360 Computers. [2 marks]

3) Ortega Football Academy’s cash flow forecast shows a closing balance of

$80,000 at the end of this month. Carlos, the finance director, then discovers
that debtors of $12,000 have yet to be included and there is an outstanding
invoice of $18,000 that needs to be paid.
Calculate the closing balance for Ortega Football Academy. [2 marks]
 Practice questions InThinking 2
4) Refer to the figures below for excerpts from Tonina & Co.’s
cash flow statement.
• Opening balance: $135,500
• Cash inflow: $532,500
• Cash outflow: $352,500
(a) Define the term cash flow statement. [2 marks]

(b) Calculate Tonina & Co.’s net cash flow. [2 marks]

(c) Calculate Tonina & Co.’s closing balance. [2 marks]

Practice questions InThinking 3
Practice questions InThinking 4
 Practice Questions 4
• Question 20.3 Menelao Stationers, page 304
 Practice Questions 5
• Question 20.5 Bereti’s Boutique, page 306
 Practice Question 6
• Question 20.4 Wincent Computing, page 305
 3.7.5 Cash Flow, profit and investment
• Investment / Capital expenditure it is the purchase of fixed assets with the
intention of creating a profit in the future. Requires a large initial amount
of cash, net cash flow may be negative in the short term. In the long term
it should generate profit and improve cash flow.
• Investment does not guarantee Profit
• It also depends on how the investment is financed, this will affect the cash
flow position
• Cash Flow is vital for investment opportunities
• Despite the risks, investment expenditure is important for an
organization’s survival and sustainability
• The lack of investment can negatively affect businesses as they fail to
adapt to changing needs and wants in the marketplace.
• The challenge for managers is to strike the right balance between capital
and revenue expenditure.
 3.7.5 Cash Flow, profit and investment
• True or False
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.
3.7.5 Cash Flow, profit and investment

Best case financial outcome Worst case financial outcome

• When managed well, a • When managed poorly, a
firm is likely to meet its firm will struggle and
long-term objectives as its eventually have to cease
growth strategies are trading.
underpinned by healthy
finances.
3.7.5 Cash Flow, profit and investment
Consistent positive net
cash flows lead to healthy
liquidity

Best case
financial Consistent profits
eventually lead to
Healthy liquidity allows
for investment into fixed
outcome consistent positive net
cash flows
assets to
maintain/increase output

Consistent (or better)

levels of output generate
consistent profits
 3.7.5 Cash Flow, profit and investment
Consistent
negative net cash
flows lead to a
poor cash balance

Reduced
Worst case productivity leads
A poor cash
balance prevents
financial to reduced profits
a firm from
or even losses,
outcome which causes
making ongoing
investments into
negative net cash
fixed assets
flows

Lack of ongoing
investment into fixed
assets results in
reduced productivity
 Exam Practice Question In Thinking 7
Ness Blackburn Bakery (NBB)
• Ness Blackburn is a sole trader
who own Ness Blackburn
Bakery (NBB) and employs six
full-time workers. The business
specialises in the sale of freshly
baked breads, cakes, pastries,
and cookies. NBB only accepts
cash payments.

• Ness has produced the

following cash flow forecast for
his business. In December, Ness
pays the workers 50% extra as
an end of year bonus.
 Exam Practice Question In Thinking 7
• (a) Define the term sole trader.[2 marks]
• (b) State the value of the following:
– (i) Net cash flow in September [1 mark]
– (ii) Cash outflow in October [1 mark]
– (iii) Opening balance in November [1 mark]
– (iv) Closing balance in December [1 mark]
• (c) Using the figures in the cash flow forecast,
comment on the liquidity position of NBB. [2 marks]
• (d) Calculate the profit earned by NBB for the
period from September to December. [2 marks]