Bm Unit 3.3 Working Capital


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IB Business and Management (Standard Level)
All material taken from the IB Business and Management Textbook:
"Business and Management", Paul Hoang, IBID Press, Victoria, 2007

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Bm Unit 3.3 Working Capital

  1. 1. Unit 3.3 working CapitalLesson 1: Working capital & cash flowpp. 360-369<br />IB Business and Management<br />
  2. 2. 1. Think about it…<br />“Don’t empty the water jar until the rain falls.”<br />- English proverb<br />What does this mean and how does it pertain to business?<br />…<br />
  3. 3. 2. Focus questions<br />1. What is cash?<br />2. What is the working capital cycle?<br />3. How is it possible to measure liquidity?<br />4. Are there any differences between cash and profit?<br />5. How can we forecast cash flow and will there be any problems?<br />…<br />
  4. 4. 3a. $$$ cash $$$<br />What do you need cash for?<br />Cash is also the lifeblood of a business.<br />Companies need cash to keep running.<br />What do they need cash for?<br />Cash is:<br />A current asset.<br />How do companies get it?<br />By selling goods or services.<br />Cash can be in hand (at the business) or at the bank.<br />What are two other assets of a company?<br />Stocks and debtors.<br />So, current assets = cash + stocks + debtors.<br />Remember this.<br />…<br />
  5. 5. 3b. $$$ cash $$$<br />Another way to obtain cash, is how easy it is to turn something into cash.<br />This is called liquidity. <br />How liquid are you?<br />Highly liquid assets are those that can be turned into cash quickly and easily without losing its value.<br />For example, money in your bank account vs. raw materials at your warehouse. <br />If your business has a cash flow problem and causes you to have insufficient working capital, this will lead to insolvency.<br />When you do not have enough working capital to meet current liabilities.<br />No money to run the business, you must close it down, and will lead to liquidation of the firm.<br />Liquidation = sell off firm’s assets to repay money owed to the creditors.<br />You do not want to be in this kind of situation.<br />So in order to avoid this we need to look at several things:<br />Working capital cycle<br />Understanding the difference between cash and profit<br />Cash flow forecasts and problems it faces<br />How to manage working capital<br />…<br />
  6. 6. 4a. Working capital cycle<br />Working capital is the money available for the daily running of a business.<br />It is also called Net Current Assets.<br />Working capital = Current Assets – Current Liabilities<br />One of the main reasons businesses fail is because of a lack of working capital.<br />Current Assets are:<br />1. Cash (money on hand or at a bank)<br />2. Debtors (people who owe YOU money)<br />3. Stocks/inventories (unsold stocks of raw material)<br />Current Liabilities are:<br />1. Overdrafts (short-term finance that YOU owe)<br />2. Creditors (your suppliers who need to be paid)<br />3. Tax (money to the government)<br />…<br />
  7. 7. 4b. Working capital cycle<br />You must consider the time difference between an order being placed and actually receiving the cash once your product has been delivered.<br />This time lag between cash payments for cost of production and receiving cash from the customer is called…<br />Working Capital Cycle.<br />Firms should have enough working capital, but not too much liquidity.<br />Too much liquidity could be viewed as wasteful and could be invested.<br />You could use the money to be more profitable.<br />
  8. 8. 5. Difference between cash & profit<br />Cash <br />Profit<br />Cash inflows can come from sales revenues.<br />Can also come from selling off unused assets, too.<br />Bank loans, donations, and grants from governments.<br />You can also have a lot of cash and be unprofitable.<br />How is this possible?<br />Remember cost can get out of control. <br />Profit= Revenue – Cost<br />Once break-even point has been reached, any sales beyond that is a profit.<br />Selling products on credit (you make a profit before you receive the cash).<br />Can be profitable and cash deficient.<br />NOTE: it is important to manage your working capital and cash flow position in order for your company to survive.<br />
  9. 9. 6a. Cash Flow forecasts<br />This is a very important financial document you MUST learn how to read and understand.<br />It shows the expected movement of cash into and out of any business in a given time period.<br />It is based on three key concepts…<br />
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  11. 11. 6c. So why the need for a forecast?<br />Reasons:<br />Banks will require you to have a cash flow forecast before lending you any money.<br />It is a tool to help YOU the manager to identify periods of cash deficiency.<br />Aids in the planning process and gives you better financial control.<br />Used as a guide to achieve your aims and objectives.<br />Used to improve your predictions and future planning and direction for the firm.<br />Let’s take a look at an example of a cash flow forecast…taken from<br />Also on pages 366-367 of your text give another example of this.<br />…<br />
  12. 12. Opening balance is the amount cash at the start of the trading period.<br />Closing balance is the amount cash at the end of the trading period.<br />
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  14. 14. Unit 3.3 working CapitalLesson 2: Management of working capitalpp. 370-376<br />IB Business and Management<br />
  15. 15. 1. Focus questions<br />1. How can managers deal with liquidity issues?<br />2. What are three major ways to deal with liquidity problems.<br />3. What are the limitations on cash flow forecasting?<br />…<br />
  16. 16. 2. Dealing with liquidity problems<br />Improving your cash flow position of a business requires you to effectively manage the working capital.<br />You must successfully manage its current assets and current liabilities.<br />Three major ways to do this:<br />1. Seek different sources of finance<br />2. Improve cash inflows<br />3. Reduce cash outflows<br />Let’s take a look at each…<br />…<br />
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  20. 20. 6. How to minimize the risks & impacts of cash flow problems<br />Have a wider customer base.<br />Avoid relying on a few big customers.<br />Ask for part-payment on long term projects.<br />Establish a way to pay large bills in regular installments.<br />Make sure you have quality management systems in place (see Unit 5.4)<br />…<br />
  21. 21. 7. Limitations of cash flow forecasts<br />Inaccuracies occur due to a number of internal and external factors:<br />Marketing: poor market research or campaign<br />Human resources: workforce may become less productive<br />Operations management: machine failure or breakdowns<br />Competitors: aggressive companies<br />Changing fashion and tastes: is your product popular this year?<br />Economic changes: see Unit 1.5<br />External shocks: war, oil crisis, etc.<br />So, there in NO guarantee that your predictions and assumptions made in the cash flow forecast will materialize.<br />A cash flow forecast is a continuous, ongoing process with regular revisions. <br />…<br />
  22. 22. end<br />