IB Business Management SLTopic 3 — Cash FlowPaper 1 & 2Core idea~10 min read
Cash, Profit and Working Capital
Businesses do not close because they stopped making a profit. They close because on a particular Friday there was not enough money in the account. Profit is an opinion about a year; cash is a fact about today.
📚 What you need to know
Profit = revenue − total costs over a period. Cash is the money actually moving in and out.
A sale on credit counts as revenue immediately but brings no cash for 30, 60 or 90 days.
A profitable business can fail if it cannot pay its bills on time.
Working capital = current assets − current liabilities. It is sometimes called net current assets.
Working capital is the money available to fund day-to-day trading — the lifeblood of the business.
Cash is the most liquid current asset. Stock and debtors are current assets but cannot pay a bill today.
Too much working capital is also a problem: idle cash and excess stock have an opportunity cost.
Why profit and cash separate
The gap opens because businesses record a sale when it happens, not when they get paid — while their own bills arrive on their own schedule. Follow one order through and you can see it.
This is why a firm can win its best ever contract and go under three months later. Winning work costs money before it earns any.
Working capital
working capital = current assets − current liabilities
The working capital cycle
Money goes round in a loop. Cash buys stock, stock is sold, the sale creates a debtor, the debtor pays and it becomes cash again. Every step takes time, and the business has to pay its own bills while the loop is still turning.
A restaurant’s loop turns in a day: buy food, cook, get paid. A shipbuilder’s takes years. That is why they need very different amounts of working capital.
Managing working capital
Convert current assets to cash faster. Chase debtors properly, discount slow-moving stock, keep less stock on the shelf.
Hold on to cash longer. Negotiate longer payment terms with suppliers so money stays in the account.
Arrange short-term borrowing. An overdraft covers gaps, though it raises current liabilities.
Do not sit on too much. Large cash balances earn little, and large stock costs storage, insurance and security.
The exam error worth avoiding: working capital is not the same as cash. It includes stock and debtors, which cannot pay a bill today. A firm can show positive working capital and still miss the wage run.
Worked examples
WORKED EXAMPLE 1
Working capital over two years [6 marks]
A components supplier reports (in $m). This year: stock 6.4, debtors 2.8, cash 0.7, short-term loan 3.9, creditors 4.2. Last year: stock 5.5, debtors 3.4, cash 1.3, short-term loan 2.6, creditors 4.6. Calculate working capital for both years and comment.
Step 1: this yearCurrent assets = 6.4 + 2.8 + 0.7 = $9.9mCurrent liabilities = 3.9 + 4.2 = $8.1mWorking capital = 9.9 − 8.1 = $1.8mStep 2: last yearCurrent assets = 5.5 + 3.4 + 1.3 = $10.2mCurrent liabilities = 2.6 + 4.6 = $7.2mWorking capital = 10.2 − 7.2 = $3.0mWorking capital has fallen from $3.0m to $1.8mStep 3: say where it went
Stock is up 0.9 and cash is down 0.6, while short-term borrowing is up 1.3. The firm is funding stock with an overdraft.
that is the sentence that earns the analysis marks — not the subtraction, the explanation of what changed
WORKED EXAMPLE 2
Profitable but broke [6 marks]
A design agency made a profit of $180,000 last year but ended it with $4,000 in the bank and an overdue tax bill. Explain how this is possible.
Step 1: separate the two ideas
Profit is revenue minus costs for the year. Cash is what actually arrived and left.
Step 2: name where the profit wentSales made on credit sit as debtors, not cash.Cash may also have gone on equipment, loan repayments or the owners’ drawings, none of which reduce profit.Step 3: draw the conclusion
The agency has earned $180,000 on paper but is holding much of it as promises from clients.
Profitable on paper, illiquid in practicethe fix is a cash flow fix: shorter credit terms, deposits up front, and a forecast so the tax bill is not a surprise
💡 Exam tip
Never use profit and cash as synonyms. Examiners are watching for exactly this.
Show current assets and current liabilities as separate lines before subtracting.
When working capital falls, say which item caused it, not just that it fell.
Mention overtrading when a case study shows fast growth and tight cash.
Remember the other side: too much working capital carries an opportunity cost.
Link to liquidity ratios — working capital is the same information in a different form.
⚠ Common mix-up
Working capital treated as cash. It includes stock and debtors, which are slower.
Assuming profit lands in the bank. Credit sales create debtors, not deposits.
Thinking a loan is income. It boosts cash and creates a liability at the same time.
Believing more stock is safer. Stock ties up cash and costs money to store.
Missing the owner’s drawings. Money taken out reduces cash without touching profit.
Calling every cash problem a loss. A cash shortage and a loss are different diagnoses with different cures.
Up next: Building a Cash Flow Forecast — the table that shows the gap before it arrives.
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