IB Business Management HLTopic 3 — Finance and AccountsPaper 1 & 2Core idea~8 min read
Cash, Profit and Working Capital
Every year, profitable businesses close down. It sounds impossible until you realise that profit is measured over a whole year, while wages and suppliers have to be paid on a particular Friday. This page is about the difference between being successful and being able to pay.
What you need to know
Profit = revenue − total costs over a period of time. It is recorded when the sale is made.
Cash is the money actually moving in and out of the bank, when it moves.
A firm can be profitable and still fail if it does not have cash when bills fall due.
Working capital = current assets − current liabilities. It funds day-to-day trading.
Working capital is sometimes called net current assets on the statement of financial position.
Too little working capital risks failure; too much means money is sitting idle.
Why profit is not cash
Imagine a workshop sells a machine for $10,000 in March, on 60-day credit. The profit statement records that sale in March. The bank account sees nothing until May. Meanwhile the workshop paid for materials and wages in March, in real money.
Both rows describe the same sale. Only the bottom row can pay the electricity bill.
A good exam sentence: “Profit is an opinion recorded on a date; cash is a fact sitting in a bank account.” Use it whenever a case study firm is profitable but struggling.
Working capital
Working capital is the money a business has available to run itself day to day — to buy stock, pay wages, and cover the gap while customers take their time.
Working capital
current assets − current liabilities
Current assets are stock, debtors and cash. Current liabilities are creditors, overdrafts and any loan repayment due within a year. A positive figure means the firm’s short-term resources cover its short-term promises.
WORKED EXAMPLE
Working capital across two years
Kabir Cycles reported the figures below. Calculate the working capital in each year and comment on the change. [4]
Item
2024 ($)
2025 ($)
Stock
36,000
44,000
Debtors
30,000
41,000
Cash
18,000
6,000
Creditors
25,000
34,000
Short-term borrowing
15,000
22,000
Step 1: add up current assets2024: 36,000 + 30,000 + 18,000 = $84,0002025: 44,000 + 41,000 + 6,000 = $91,000Step 2: add up current liabilities2024: 25,000 + 15,000 = $40,0002025: 34,000 + 22,000 = $56,000Step 3: subtract2024: 84,000 − 40,000 = $44,0002025: 91,000 − 56,000 = $35,000Working capital fell by $9,000Look closer: current assets actually rose, but the growth is all in stock and debtors while cash fell from $18,000 to $6,000. The firm is bigger on paper and weaker at the till.
The working capital cycle
Cash does not sit still in a trading business. It goes out to buy stock, waits on a shelf, becomes a sale, waits again as a debtor, and finally comes back as cash. The faster that loop turns, the less money the firm needs tied up in it.
Stock turnover and debtor days are simply measurements of two stages of this loop.
Managing working capital
Working capital is called the lifeblood of a business for a reason: without it the firm cannot meet its immediate obligations, and that is what usually forces closure rather than a bad product.
Turn slow assets into cash. Chase debtors properly and discount stock that is not moving.
Ask suppliers for longer terms. Cash stays in the business for more days.
Use an overdraft for genuine short gaps, not as permanent funding — interest adds up.
Keep the forecast up to date so a squeeze is spotted weeks before it bites.
You can have too much. A pile of cash earns nothing, especially when interest rates are high, and a warehouse full of stock costs storage, insurance and security. That is an opportunity cost.
Liquidity position
Liquidity is a business’s ability to meet short-term commitments with the assets it has available. The statement of financial position is where you find the evidence, and the current and acid test ratios are how you measure it.
The connection to remember is simple: working capital is the amount, liquidity is the quality. A firm can have $35,000 of working capital that is almost all stock, which is a very different position from $35,000 sitting in cash.
Exam tip
If a case study says “profitable but struggling”, the answer is nearly always a cash flow or working capital problem.
Working capital is a dollar amount. The current ratio is the same idea expressed as a ratio.
Show your current assets and current liabilities subtotals separately — they usually carry a mark each.
Look at what working capital is made of, not just the total.
Overdrafts are current liabilities, so an overdraft reduces working capital.
Link your answer to the industry: seasonal firms plan for predictable cash dips.
Common mix-up
Saying cash and profit are the same. They are measured at different moments and by different rules.
Saying working capital is cash. It also includes stock and debtors, which cannot pay a bill today.
Including fixed assets. Only current items belong in working capital.
Assuming rising current assets is good news. It depends whether the rise is cash or unsold stock.
Thinking more working capital is always better. Idle resources have an opportunity cost.
Forgetting the loan repayment due this year. That part of a long-term loan is a current liability.
Up next: Building a Cash Flow Forecast — the table that predicts a cash squeeze before it happens.
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