Working Capital & Key Terms
100 — Working capital is calculated as current assets minus this.
Current liabilities
Cash flow is the sum of cash payments into a business minus cash payments out of the business.
Cash flow
This is an estimate of the future cash inflows and cash outflows of a business.
Cash flow forecast
One way to improve net cash flow is to increase cash inflows or do this.
Reduce cash outflows
This is profit after tax that is kept in the business rather than paid out as dividends.
Retained earnings (or Retained profit)
The coursebook calls this “the finance needed by all businesses to pay for everyday expenses, such as wages and buying inventory.”
Working capital
Many business failures result from owners not understanding the difference between cash and this.
Profit
What causes a closing balance to be negative at the end of the month?
Cash outflows are higher than cash inflows (or net cash flow is negative
This problem happens when a business expands too rapidly without enough finance.
Overtrading
Identify three internal sources of finance
retained profit, sale of unwanted assets, reductions in working capital, and sale and leaseback of non-current assets.
This diagram in the book shows the cycle: materials → production → inventory → sales → cash paid by customers.
The working capital cycle
A business can be making this but still run out of cash and become insolvent.
Profit
Name two benefits of preparing a cash flow forecast
Any two: shows negative closing balances early, helps source finance, indicates when to improve cash flow, essential for business plans, helps banks/investors
Name one method to increase cash inflows and one drawback.
Examples: Overdraft (high interest), Sale of assets (may need them later), Sale and leaseback (ongoing lease costs)
Name two short-term external sources of finance mentioned in the coursebook.
Bank overdraft, trade credit, debt factoring
The ability of a business to pay its short-term debts when they fall due.
Liquidity
In the coursebook, Sanjit sells jewellery rings for $4000 but does not receive the cash for two months. What does the coursebook say this creates, even though revenue has been recorded?
A negstive cash flow
The coursebook says cash flow forecasts help avoid this major cause of cash flow problems.
Lack of planning
This method reduces outflows by waiting to buy/upgrade new equipment
Delay capital expenditure
This long-term source allows a business to use an asset without buying it outright and involves regular payments to a leasing company.
Leasing
Capital expenditure is the purchase of non-current assets expected to last more than one year. Give the definition of revenue expenditure.
Spending on all costs and assets other than non-current assets (e.g. wages, inventory of materials)
Explain why cash is more important than profit in the short term according to the book.
A business can be profitable on paper but still fail if it runs out of cash to pay its short-term debts (liquidity crisis).
An engineering business has cash “drying up” because customers keep calling and saying they want longer credit. Recommend and justify two methods he could use.
Any two justified: Reduce credit period / chase payments faster; Offer prompt-payment discounts; Use debt factoring; Delay payments to suppliers; Cut overheads, etc.
This is risk capital invested in small or growing businesses by specialist investors in return for a share of ownership and profits.
Venture capital