IB DP Business Management: Cash flow – Practice Questions

These are original questions written for Marlbridge, for revision and practice on this content. They are not reproduced past-paper questions, and they do not replicate the exam’s exact structure, question count or mark tariffs – the IB holds copyright in its own papers. Use these alongside the official past papers available through your school or the IB store.

These questions cover section 3.7 (Cash flow) of Unit 3 in the IB Business management guide, first assessment 2024, for SL and HL students. Learn the content from the study guide and the revision notes. Other links: the course hub, the printable checklist and the Unit 3 practice set. Money is in dollars unless stated. Every business is invented.

Questions

1. Define the term working capital. [2]

2. Distinguish between profit and cash flow. [3]

3. Larkmere Bikes is a bicycle shop. Its year-end figures in thousands of dollars are: stock 38; trade receivables 21; cash 6; trade payables 30; bank overdraft 18; tax due 12.

(a) Calculate working capital. [2] (b) Calculate the acid test (quick) ratio, to two decimal places. [2] (c) Analyse the liquidity position of Larkmere Bikes. [3]

4. Identify two reasons why a profitable business may run short of cash. [2]

5. Sandhurst Kiln is a pottery studio. It opens January with 2,000 cash. Forecast receipts for January to April are 6,500, 5,200, 7,800 and 9,100. Forecast payments are 7,400, 6,100, 12,600 and 6,300; the March payments include a new kiln costing 5,000.

(a) Calculate the net cash flow and closing balance for each month. [4] (b) Identify the first month in which the forecast closing balance is negative. [1]

6. Zindel Audio pays 60,000 cash for a new assembly line, expected to last five years with annual depreciation of 12,000. Explain the effect of this investment on cash flow and profit in the first year. [4]

7. Explain how selling invoices to a debt factor could help a business with a cash flow problem. [3]

8. Analyse two limitations of a cash flow forecast. [4]

9. Explain why a lender or supplier may be interested in a business’s liquidity position. [3]

10. Gannet Quay Tours runs boat trips. Its forecast for the autumn is below, with an opening balance in October of 8,000.

	Oct	Nov	Dec
Total receipts	14,000	9,000	7,000
Total payments	12,000	15,500	12,000

The November payments include a supplier invoice of 5,200 that the supplier says could be paid in January instead.

(a) Calculate the closing balance in each month. [3] (b) Recommend whether the owner should arrange an overdraft or ask the supplier to delay the 5,200 invoice. Justify your answer. [6]

11. Linnet Row Fabrics reported a profit of 22,000 for the year. Its cash fell from 39,500 to 1,500. Depreciation was 3,000. Trade receivables rose by 25,000 and stock rose by 14,000. The owner paid 18,000 cash for a delivery van and repaid 6,000 of a loan. Ignore tax, interest and drawings, and assume trade payables did not change.

(a) Using a profit-to-cash bridge (an extension beyond the guide’s wording), show how a profit of 22,000 is consistent with a cash fall of 38,000. [4] (b) Recommend one strategy to improve the cash position and justify it. [4]

Answers

1. Working capital is the funding available for everyday operating needs [1], found as current assets minus current liabilities [1]. [2] Examiner insight: Credit comes from saying what working capital is for as well as how it is found; the formula by itself leaves the purpose unstated.

2. Profit is what remains after deducting costs from sales revenue for a period, with each item counted when earned or incurred [1]. Cash flow is the real receipt and payment of money by the business [1]. They differ in timing, for example a credit sale raises profit now but brings cash later [1]. [3] Examiner insight: “Distinguish” needs both sides stated against each other; describing only profit leaves the comparison incomplete.

3. (a) Current assets = 38 + 21 + 6 = 65 [1]. Current liabilities = 30 + 18 + 12 = 60, so working capital = 65 - 60 = 5 (thousand dollars) [1]. (b) Acid test = (65 - 38) / 60 [1] = 27 / 60 = 0.45 [1]. (c) The current ratio is about 1.08, which looks barely adequate [1]. The acid test ratio of 0.45 is well below 1, so without selling stock the shop could meet less than half of its short-term debts [1]. Much of the current assets is stock, and bicycle stock may take time to sell, so liquidity is weak, though selling stock would improve it [1]. [7] Examiner insight: Answers that quote a ratio and stop tend to gain less than ones that say what the ratio means for this shop; always tie the number to the business.

4. Any two from: customers have not yet paid for credit sales [1]; cash was spent on equipment or stock that does not reduce profit now [1]; loan repayments, which are not an expense of the period; paying suppliers earlier than customers pay. [2] Examiner insight: Two distinct reasons are needed; restating the same idea twice earns the first point only.

5. (a) Jan: net 6,500 - 7,400 = -900, closing 2,000 - 900 = 1,100 [1]. Feb: net -900, closing 200 [1]. Mar: net 7,800 - 12,600 = -4,800, closing 200 - 4,800 = -4,600 [1]. Apr: net 9,100 - 6,300 = 2,800, closing -4,600 + 2,800 = -1,800 [1]. (b) March [1]. [5] Examiner insight: Each month’s opening balance must equal the previous closing balance; an error early on spoils the rest of the table, so show each line.

6. Cash falls by the full 60,000 as soon as it is paid [1]. Profit is reduced only by the depreciation charge of 12,000 in the year [1]. Depreciation is a non-cash charge, so profit falls by much less than cash does [1]. The line may raise sales revenue and profit in later years, so the cash outflow is repaid over time [1]. [4] Examiner insight: Strong answers compare the two figures, 60,000 against 12,000, rather than describing each separately.

7. The business sells unpaid invoices to a factor [1]. It receives most of the invoice value at once instead of waiting for customers [1]. This brings cash in earlier, though a fee is charged so the business gets less in total [1]. [3] Examiner insight: Mention of the fee or lower total received is the kind of balance that turns a description into an explanation.

8. Limitation one: it relies on assumptions about sales and when customers pay [1], so if sales are lower or customers pay late the forecast balances will be too high [1]. Limitation two: unexpected events such as a supplier price rise or breakdown cannot be predicted [1], so the plan may mislead managers who rely on it [1]. [4] Examiner insight: For “analyse”, naming a limitation earns less than following it through to its effect on decisions.

9. Liquidity shows whether the business can pay debts due soon [1]. A lender wants to know repayments will be made, so a weak position raises risk [1]. A supplier wants to be paid for goods supplied on credit, so may refuse credit if liquidity is poor [1]. [3] Examiner insight: Naming the stakeholder and the decision they make from the information is what separates this from a generic answer.

10. (a) Oct: net 14,000 - 12,000 = 2,000, closing 8,000 + 2,000 = 10,000 [1]. Nov: net 9,000 - 15,500 = -6,500, closing 3,500 [1]. Dec: net 7,000 - 12,000 = -5,000, closing -1,500 [1]. (b) Without action the business is overdrawn by 1,500 at the end of December [1]. An overdraft of a modest size would cover this, is quick to arrange and the need is short term and seasonal [1], but it carries interest and the bank may withdraw it [1]. Delaying the 5,200 invoice to January gives a November closing balance of 8,700 and a December balance of 3,700, so no overdraft is needed [1], but the supplier might lose goodwill or charge more, and the payment still falls due in January in a quiet period [1]. Judgement: ask the supplier first, since it removes the shortfall at no interest cost, with a small overdraft agreed as back-up in case the supplier refuses [1]. [9] Examiner insight: A recommendation that weighs both options against the 1,500 shortfall and then chooses one is what an evaluative answer needs; listing options with no choice is incomplete.

11. (a) Start with profit 22,000 and add back depreciation 3,000 as no cash left [1]. Subtract the rise in receivables 25,000 and the rise in stock 14,000, as cash is tied up in each [1]. Subtract the van 18,000 and the loan repayment 6,000 [1]. 22,000 + 3,000 - 25,000 - 14,000 - 18,000 - 6,000 = -38,000, and 39,500 - 38,000 = 1,500 [1]. (b) Recommend chasing receivables and offering a small discount for early payment [1], because the 25,000 rise in receivables is the largest single drain on cash [1]. It could bring cash in quickly without borrowing [1], but the discount lowers revenue and firm credit terms might lose customers, so the benefit should be weighed against that cost [1]. [8] Examiner insight: Pick the strategy that targets the largest cause in the data and say why; a strategy unconnected to the figures usually gains less.

Where marks are usually lost

• Giving a formula for working capital without saying what it shows.
• Defining profit when asked about cash flow, or the reverse.
• Quoting a ratio but never saying what it implies for this particular firm.
• Putting depreciation into a forecast, or entering a credit sale in the month of sale.
• Breaking the chain between closing and opening balances.
• Treating a negative closing balance as a loss rather than a shortfall.
• Listing strategies with no link to the cause of the problem.
• Failing to reach a judgement when asked to recommend, justify or evaluate.

Next steps

• Revise with the cash flow revision notes and the study guide.
• Visit the IB Business Management hub and tick off topics on the printable checklist.
• Take any of the free 10-minute diagnostics.
• Book a free trial class.

Frequently asked questions

What do these cash flow practice questions cover? They cover section 3.7 of the IB DP Business Management guide (first assessment 2024), for SL and HL: the difference between profit and cash flow, working capital, liquidity, cash flow forecasts, investment and strategies for cash flow problems.

Should depreciation appear in a cash flow forecast? No. Depreciation is a non-cash charge, so it is left out of a cash flow forecast. Entering a credit sale in the month of sale rather than the month of payment is another common error.

Does a negative closing balance mean a loss? No. A negative closing balance is a cash shortfall, not a loss. The business may need a short-term source of finance or a delayed payment.

How should you recommend a strategy for a cash flow problem? Match the strategy to the cause of the problem, weigh its drawbacks against alternatives in the context of the case, and reach a judgement.

Official syllabus

IB Business management guide, first assessment 2024, International Baccalaureate Organization. Section 3.7 Cash flow.