IB Business Management HLTopic 3 — Finance and AccountsPaper 1 & 2Core idea~9 min read
Fixing a Cash Flow Problem
The forecast has shown a gap. Now what? Every solution in this topic does one of two things: it gets money in faster, or it pushes money out later. What separates a good answer from an average one is naming the price the business pays for each fix.
What you need to know
The best long-term fix is to manage the business better: forecast, budget and set clear financial objectives.
Short-term fixes either speed up inflows or slow down outflows.
Every fix has a cost — interest, lost customers, unhappy suppliers or lost control.
Investment, profit and cash flow behave differently at each stage of a business’s life.
A business can also hold too much cash, which carries an opportunity cost.
Cash flow problems are often a symptom. Find the cause in the case study before recommending a cure.
Only two taps
Think of the bank balance as the level of water in a tank. One pipe fills it and one pipe empties it. If the level is falling, either the inflow is too slow or the outflow is too fast. There is genuinely nothing else.
Draw this tank in the margin of an exam paper and you will never run out of suggestions.
Methods to improve cash flow
Each row below is a genuine solution used by real firms. The third column is where the evaluation marks are.
Method
How it helps cash flow
What it costs the business
Reduce the credit period given to customers
Money owed turns into cash sooner, raising current assets
Customers may switch to rivals offering easier terms
Ask suppliers to extend payment terms, say 60 to 90 days
Cash stays in the business longer and can be used elsewhere
Suppliers may refuse, charge more, or delay orders
Use an overdraft or short-term loan
Immediate access to money when there is a short gap
Interest costs, and current liabilities increase
Sell off excess stock
Turns slow assets into cash and cuts storage and security costs
Usually needs a discount, so profit per unit falls
Sale and leaseback of fixed assets
A large one-off cash injection while still using the asset
Regular lease payments forever, and the asset is no longer owned
Introduce new capital and reduce owner drawings
Current assets rise without new borrowing
Bringing in investors dilutes control of the business
Delay or cancel planned investment
A big outflow disappears from the forecast
The firm may fall behind rivals on capacity or technology
Match the fix to the size and shape of the problem. A short, one-month dip needs an overdraft. A gap that appears every single month is a business model problem, and no amount of borrowing will fix it.
Better management, not just borrowing
Forecast regularly so problems appear on paper before they appear in the bank.
Budget carefully, and consider zero-based budgeting so every cost has to justify itself.
Set clear financial objectives and hunt for ways to raise inflows and trim outflows.
Improve stock control. Less stock on the shelf means less cash sitting still.
Cash flow changes as a business grows
A negative cash flow is not automatically bad news. It is completely normal at the start, when the owner is buying equipment and nobody has heard of the business yet. What matters is whether the pattern matches the stage the firm is at.
Investment falls and profit rises as the business matures, and cash flow follows profit with a lag.
Too much cash is a problem too
It sounds like a nice problem to have, and it is, but idle cash earns nothing. If a business is sitting on a large balance it is missing out on the return it could get from investing in new equipment, new products, or even a savings account. When interest rates are high, that opportunity cost gets expensive.
Investment, profit and cash flow are three different things. Buying a delivery van is an investment. It reduces cash immediately, may reduce profit slightly through depreciation, and should raise both in later years.
Answering “recommend how to improve cash flow”
Name the cause from the case study — slow debtors, seasonal sales, overstocking, a big one-off cost.
Choose two methods that actually match that cause.
Explain the effect on the forecast, ideally with a number from the stimulus.
State the drawback of each method.
Recommend one and justify why it suits this firm, at this size, right now.
Exam tip
Never write “get a loan” on its own. Say what kind, how much, and what it costs.
Say whether your fix is short term or long term. Examiners reward that distinction.
Selling assets raises cash once. It does not fix a monthly shortfall.
