IB DP Business Management: Cash flow – Revision Notes

These notes condense section 3.7 (Cash flow) of Unit 3 in the IB Business management guide, first assessment 2024. All six content points apply at SL and HL. For fuller explanations and longer worked examples, read the study guide first, then test yourself with the practice questions. Related pages: the Unit 3 revision notes, the course hub, the printable checklist and the free diagnostics.

The six content points at a glance

Point in 3.7	One-line summary	Depth
Difference between profit and cash flow	Profit follows earning and incurring; cash flow follows payment and receipt	AO2
Working capital	Current assets minus current liabilities	AO2, AO4
Liquidity position	Capacity to meet debts due within a year	AO2
Cash flow forecasts	Month-by-month plan of cash in, cash out, closing balance	AO2, AO4
Investment, profit and cash flow	Cash leaves at once; profit falls gradually; returns come later	AO2
Strategies for cash flow problems	Match the fix to the cause and weigh drawbacks	AO3

Definitions

Term	Meaning
Cash flow	Money actually received and paid out during a period
Profit	Sales revenue minus costs for the period
Net cash flow	Cash inflows minus cash outflows in a period
Working capital	Funds available for day-to-day operations
Liquidity	Ability to pay short-term debts when due
Cash flow forecast	Prediction of future cash inflows, outflows and balances
Current assets	Stock, trade receivables, cash and similar items due to become cash within a year
Current liabilities	Amounts owed that fall due within a year
Investment	Spending on assets to earn returns later

Terms the guide asks you to use in assessment: “statement of profit or loss” (the guide notes the older name profit and loss account, also called an income statement) and “statement of financial position” (the older name is balance sheet).

Formulae

Measure	Form	Source
Working capital	current assets - current liabilities	Standard form
Current ratio	current assets / current liabilities	Given in the guide’s formulae for 3.5
Acid test (quick) ratio	(current assets - stock) / current liabilities	Given in the guide’s formulae for 3.5
Net cash flow	total inflows - total outflows	Standard form
Closing balance	opening balance + net cash flow	Standard form

Profit versus cash flow: the checklist

Ask these questions about any period.

1. Did customers pay in the period, or only receive goods?
2. Did the business pay suppliers in the period, or buy on credit?
3. Was an asset bought for cash?
4. Is there a non-cash charge such as depreciation?
5. Were loans repaid or received?

Cash outflow with no effect on profit: equipment bought, loan repayments, stock bought but not yet sold. Profit cost with no cash outflow: depreciation, and costs bought on credit and not yet paid.

Worked reminder: Brindle Row Bakery

Brindle Row Bakery sells through shops and cafes. In one month it sells 9,000 of bread and cakes. Of this, 5,500 is paid in cash on the day and 3,500 is on 30-day credit. Costs paid in cash that month are 6,800. Profit before any non-cash items = 9,000 - 6,800 = 2,200. Cash received = 5,500 and cash paid = 6,800, so net cash flow = -1,300. The 3,500 owed by cafes explains the gap between the two figures: 2,200 profit but 1,300 less cash.

Working capital and liquidity

Method in steps:

1. List current assets and add them.
2. List current liabilities and add them.
3. Working capital = step 1 - step 2.
4. Current ratio = step 1 / step 2.
5. Acid test ratio = (step 1 - stock) / step 2.
6. Comment on the result and on what sits inside it.

Worked reminder (Brindle Row Bakery, year end): stock 4,000, trade receivables 4,000, cash 2,400; trade payables 5,100, overdraft 2,000, tax owed 900. Current assets are 10,400 and current liabilities are 8,000.

• Working capital = 10,400 - 8,000 = 2,400.
• Current ratio = 10,400 / 8,000 = 1.30.
• Acid test ratio = 6,400 / 8,000 = 0.80.

Comment: working capital is positive, but without stock the business cannot quite cover its short-term debts at once (0.80 is below 1). Stock for a bakery goes off fast, so the acid test ratio is the fairer test.

Must-know distinctions:

• Liquidity is about the short term. Profitability is about earning over a period. A business can have either without the other.
• Too little working capital risks missed payments. Too much leaves resources idle.
• A high current ratio built on slow receivables or unsold stock is weaker than it looks.

Cash flow forecasts

Layout in order: opening balance, cash inflows, cash outflows, net cash flow, closing balance. Last month’s closing balance is next month’s opening balance. The guide says forecasts in case studies will follow its presentation layout, so check your own copy of the guide for the exact rows.

Method in steps:

1. Move each sale to the month the customer pays.
2. Move each cost to the month the supplier or employee is paid.
3. Leave out depreciation.
4. Total inflows and outflows for each month.
5. Find net cash flow by taking outflows from inflows.
6. Add that net figure to the opening balance to get the closing balance.
7. Roll the closing balance forward as the next month’s opening figure.

Worked reminder: opening balance 2,000, inflows 9,000, outflows 11,500. Net cash flow = -2,500, closing balance = -500. The business is overdrawn by 500 and needs a short-term source or a delayed payment.

Use of a forecast	Limitation
Shows when shortfalls will occur	Relies on assumptions about sales and payment dates
Supports a loan or overdraft request	Unexpected events make it wrong
Lets managers test a decision in advance	Accuracy falls the further ahead it looks
Helps plan the timing of investment	Takes time and information to prepare

Investment, profit and cash flow

• Day of purchase: cash falls by the full price.
• Each year: profit falls by the depreciation charge only. The calculation methods are HL only in 3.4, so here only remember that the charge is non-cash.
• Later: sales revenue, profit and cash inflows may rise if the investment works.
• Stock investment ties up working capital until the stock is sold.
• Result: a business can look profitable and still run short of cash in the year it invests.

Strategies

Pick by cause. The guide does not list strategies, so this table is standard teaching content. The AO3 skill is weighing a strategy against alternatives and the context.

Cause	Sensible strategies	Watch out for
Short timing gap	Overdraft, delay supplier payments	Interest; strained supplier relations
Slow customers	Chase receivables, shorter credit terms, early-payment discount, factoring	Lost customers; lower revenue; fee
Large purchase	Lease instead of buy, sale and leaseback, delay the purchase	Higher total cost; lost asset
Excess stock	Reduce stock, stricter ordering	Stock-outs
Persistent losses	Cut costs, raise prices, restructure	Short-term cash fixes only postpone failure

Quick self-test

1. State the formula for working capital.
2. Give two reasons a profitable business can have negative net cash flow.
3. A business has current assets of 52,000, stock of 20,000 and current liabilities of 40,000. Calculate the current ratio.
4. Using the data in question 3, calculate the acid test ratio.
5. Opening balance 4,200, inflows 11,000, outflows 13,600. Calculate the closing balance.
6. Does depreciation appear in a cash flow forecast? Explain.
7. A firm buys a machine for 30,000 cash. State the immediate effect on cash and the effect on profit that year if depreciation is 6,000.
8. Identify two strategies for a business with slow-paying customers.
9. State one limitation of a cash flow forecast.
10. Explain why a very high working capital figure may not be a good sign.

Answers

1. Current assets minus current liabilities.
2. Customers have not yet paid for credit sales; cash was spent on equipment, repayments or stock that does not reduce profit now.
3. 52,000 / 40,000 = 1.3.
4. (52,000 - 20,000) / 40,000 = 32,000 / 40,000 = 0.8.
5. Net = 11,000 - 13,600 = -2,600. Closing = 4,200 - 2,600 = 1,600.
6. No. Depreciation is a non-cash charge, so no money moves.
7. Cash falls by 30,000 at once; profit is reduced by 6,000 for the year.
8. Any two: shorter credit terms, chasing overdue invoices, early-payment discount, debt factoring.
9. It depends on assumptions that may prove wrong, or events that cannot be foreseen.
10. Cash or stock may be sitting idle, not earning a return, or the figure may be inflated by unsold stock or slow-paying customers.

Where marks are usually lost

• Writing a definition of cash flow that is really a definition of profit.
• Leaving out the context. A profit versus cash answer needs the business’s own credit sales, purchase or timing.
• Putting depreciation into a forecast.
• Starting a month with a balance that does not match last month’s closing balance.
• Quoting a ratio but never saying what it implies for this particular firm.
• Offering a strategy with no link to the cause, or with no drawback, in an evaluative answer.
• Reaching no judgement when asked to evaluate, justify or recommend.
• Quoting a figure without units or with the wrong sign when it is negative.

Frequently asked questions

What is the difference between profit and cash flow? Profit is sales revenue minus costs and follows when revenue is earned and costs are incurred. Cash flow is money actually received and paid out, so it follows the timing of payments and receipts.

How do you calculate working capital? Working capital is current assets minus current liabilities. It shows the funds available for day-to-day operations.

Why is the acid test ratio stricter than the current ratio? The acid test ratio removes stock from current assets before dividing by current liabilities. It is a fairer test where stock is slow to sell or perishable.

How does an investment affect cash flow and profit differently? Cash falls by the full price on the day of purchase, while profit falls only by the depreciation charge each year. A business can look profitable and still run short of cash in the year it invests.

Official syllabus

IB Business management guide, first assessment 2024, International Baccalaureate Organization. Section 3.7 Cash flow. Related: sections 3.4 and 3.5.