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Cambridge IGCSE0450

Cash-flow forecasting and working capital

Business Studies 0450 Chapter Notes

What this chapter covers

Cash-flow forecasting and working capital - The importance of cash and of cash-flow forecastingCash-flow forecasting and working capital - Working capital
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In this chapter

  1. 1Why cash matters to a business
  2. 2What a cash-flow forecast is and why it matters
  3. 3Constructing and completing a simple forecast
  4. 4Interpreting a forecast
  5. 5Overcoming a short-term cash-flow problem
  6. 6Choosing the best way
  7. 7What working capital is
  8. 8Current assets and current liabilities
  9. 9Calculating working capital
  10. 10Why a business needs working capital
  11. 11Applying the importance to the business
  12. 12Working capital is not profit or long-term capital

1. Why cash matters to a business

A business needs cash to pay wages, to pay suppliers, and to pay bills such as heating, rent, insurance and taxes.

Cash is also needed to repay short-term debts and to meet unexpected costs. A business that cannot pay what it owes may be forced to close, so cash helps to ensure business survival.

Cash is not profit. Day-to-day expenses are paid with cash, and profit is not a cash inflow.

Examiner insight

“A common mistake was to select similar points which had been classified together in the mark scheme. For example, paying wages and paying suppliers are both examples of day-to-day costs so this is classed as repetition.” “A common mistake was to refer to profit which is not a cash inflow.”

Worked example 14 marks

OBZ uses job production to manufacture carpets. The business has 80 employees. The table is an extract from OBZ's financial data at 30 December 2025 ($000).

Outline two reasons why OBZ needs to manage its cash.

ItemValue
non-current assets800
current assets300
current liabilities240
  1. 1

    Knowledge: to pay wages. [1]

  2. 2

    Application: the wages of its 80 employees. [1]

  3. 3

    Knowledge: to repay short-term debts. [1]

  4. 4

    Application: its current liabilities of $240 000 are owed. [1]

2. What a cash-flow forecast is and why it matters

A cash-flow forecast records the cash inflows and outflows a business expects over a future period, month by month. It is forward looking: none of it has happened yet.

A business uses it to plan and budget, to predict cash-flow problems before they arrive, and to support loan applications. A lender can see whether the business is able to pay.

A forecast tracks cash, not profit. It cannot be used to measure profit, loss or working capital.

Examiner insight

“Most candidates understood that a cash flow forecast recorded cash inflows and outflows, but not that it was forward looking.” “A common mistake was to assume that a cash flow forecast could be used to measure profit, loss or working capital.”

Worked example 16 marks

MCL is a wholesaler which sells fruit and vegetables. George is reviewing MCL's cash flow forecast ($000).

Explain two ways George could use MCL's cash flow forecast.

JulyAugustSeptember
cash inflowX400380
cash outflow300420350
net cash flow80(20)30
opening balance70150130
closing balance150130Y
  1. 1

    Knowledge: to show if MCL is likely to run short of cash. [1]

  2. 2

    Application: the forecast has a net cash flow of minus $20 000 in August. [1]

  3. 3

    Analysis: so George can cut back on spending or take corrective action in good time. [1]

  4. 4

    Knowledge: to support a loan application. [1]

  5. 5

    Application: MCL operates in a competitive market. [1]

  6. 6

    Analysis: the forecast shows whether MCL could afford to pay the interest. [1]

3. Constructing and completing a simple forecast

A simple forecast has five rows for each month. Cash inflow is cash coming in: cash sales, money from trade receivables, loans and money from the owner. Cash outflow is cash going out: wages, payments to suppliers and other bills.

Net cash flow is inflow minus outflow. It is negative, written in brackets, when more cash goes out than comes in.

The opening balance is the amount of cash the business has at the start of the month. To find it, copy last month's closing balance, but do not give that as its definition. The closing balance is the opening balance plus the net cash flow.

net cash flow = cash inflow - cash outflow

closing balance = opening balance + net cash flow

opening balance (this month) = closing balance (last month)

Examiner insight

“Many answers lacked precision so used vague words such as ‘funds’ or ‘capital’ which are not the same as cash.” “Some candidates did not represent the answers as negative values.”

Worked example 12 marks

George is reviewing MCL's cash flow forecast ($000).

Calculate X and Y.

JulyAugustSeptember
cash inflowX400380
cash outflow300420350
net cash flow80(20)30
opening balance70150130
closing balance150130Y
  1. 1

    Net cash flow = inflow − outflow, so X - 300 = 80 and X = 380. [1]

  2. 2

    Closing balance = opening balance + net cash flow, so Y = 130 + 30 = 160. [1]

4. Interpreting a forecast

Read the closing balance first. A negative closing balance means the business expects to run short of cash and may be unable to pay its bills. This is a liquidity problem, and it makes a bank loan difficult to get.

A negative net cash flow means more cash goes out than comes in. A large positive closing balance can mean holding too much cash. A negative balance is a cash shortage, not a loss.

Examiner insight

“Answers often highlighted that sales had gone down or December had a negative closing balance but did not say what this meant for the business.”

Worked example 16 marks

Brightleaf Café sells coffee to office workers. This is its cash-flow forecast ($000).

Explain two things the forecast tells the owner about the café's cash position.

OctoberNovemberDecember
cash inflow302422
cash outflow263129
net cash flow4(7)(7)
opening balance6103
closing balance103(4)
  1. 1

    Knowledge: the café expects to run short of cash. [1]

  2. 2

    Application: the closing balance in December is (4), which is minus $4 000. [1]

  3. 3

    Analysis: the café will not be able to pay all its bills that month, a liquidity problem. [1]

  4. 4

    Knowledge: more cash is expected to go out than to come in. [1]

  5. 5

    Application: net cash flow is (7) in both November and December. [1]

  6. 6

    Analysis: the café is using up its cash, so a bank would doubt it is able to repay a loan. [1]

5. Overcoming a short-term cash-flow problem

A short-term cash-flow problem is a shortage of cash soon. Most ways to solve it increase cash inflow or reduce cash outflow now. Always explain that direct effect.

An overdraft lets a business spend more than it has in its bank account, so bills are still paid while the balance is negative. Delaying payments to suppliers keeps cash in the business for longer, so cash outflow falls. Asking debtors to pay more quickly brings in cash the business is already owed, so cash inflow rises.

Do not mix up trade payables, which are owed to suppliers, and trade receivables, which are owed by customers. Ways to increase profit and long-term solutions do not answer the question.

Examiner insight

“Instead of analysis, most candidates stated such methods would improve cash-flow without explaining the direct effect on cash inflow or cash outflow.” “Some confused the concepts of trade payables with trade receivables.”

Worked example 16 marks

Hartley Bakery supplies bread to 12 local cafés. The cafés pay 60 days after delivery. Hartley Bakery's cash-flow forecast has a negative closing balance in March.

Explain two ways Hartley Bakery could overcome this short-term cash-flow problem.

  1. 1

    Knowledge: ask debtors to pay more quickly. [1]

  2. 2

    Application: the 12 cafés currently pay 60 days after delivery. [1]

  3. 3

    Analysis: cash comes in sooner, so cash inflow in March rises and the closing balance goes up. [1]

  4. 4

    Knowledge: arrange an overdraft. [1]

  5. 5

    Application: the bakery can still pay for flour and wages in March. [1]

  6. 6

    Analysis: the bank allows the balance to go below zero, so the bills are paid on time. [1]

6. Choosing the best way

A good answer weighs one way against the alternatives, such as an overdraft or delaying payments to suppliers, and justifies a decision.

Asking customers to pay more quickly could lead to fewer customers. An overdraft is short-term finance, which suits a short-term problem.

Give the reason the chosen way beats the others, using the business's own facts. Do not just repeat earlier points in the conclusion.

Examiner insight

“Evaluation was rarely awarded as candidates offered an unsupported decision or simply restated points previously made in their answer.” “Some responses recognised that asking customers to pay more quickly could lead to fewer customers.”

Worked example 16 marks

Dunmore Dairy sells milk to 20 shops, which pay 45 days after delivery. Its owner, Tomasz, has a forecast with a cash shortage next month only. He can ask the shops to pay within 14 days, or he can arrange an overdraft.

Do you think asking the shops to pay sooner is the better way? Justify your answer.

  1. 1

    Knowledge: asking debtors to pay more quickly brings in cash that is already owed. [1]

  2. 2

    Analysis: cash inflow rises next month, so the shortage gets smaller or disappears. [1]

  3. 3

    Knowledge: it could lead to fewer customers. [1]

  4. 4

    Analysis: a shop that dislikes paying within 14 days may buy its milk elsewhere, so cash inflow falls in later months. [1]

  5. 5

    Evaluation: decision: no, the overdraft is the better way. [1]

  6. 6

    Evaluation: reason: the shortage lasts one month, so short-term finance covers it, but a shop that leaves is lost for good. [1]

Recap

  • Cash pays wages, suppliers, bills and short-term debts, and keeps a business alive.
  • A cash-flow forecast is a forward-looking record of expected cash inflows and outflows. It is not profit.
  • Net cash flow = inflow − outflow. Closing balance = opening balance + net cash flow.
  • This month's opening balance is last month's closing balance.
  • A negative closing balance means a cash shortage, not a loss. Say what it means for the business.
  • Explain each way to fix a shortage by its effect on cash inflow or cash outflow.
  • Evaluation needs a decision and a reason that beats the other ways.

7. What working capital is

Working capital is the funds a business uses to pay its day-to-day costs. It is money for wages, suppliers and bills. It is not the costs themselves.

Examiner insight

“A common mistake was to assume working capital is the day-to-day costs rather than the funds used to pay them.” “Comments about being the ‘lifeblood of the business’ or ‘keep the business running’ were not credited as they do not define the term.”

Worked example 12 marks

Hana runs Brightside Bakery, which sells bread and cakes to local cafés. She pays her bakers every Friday. Define ‘working capital’.

  1. 1

    Knowledge: the funds a business uses [1]

  2. 2

    Knowledge: to pay its day-to-day costs (expenses) [1]

8. Current assets and current liabilities

A current asset is an item the business owns or holds for less than one year.

A current liability is a debt the business must repay in less than 12 months. Working capital is worked out from these two.

Examiner insight

“A common mistake was to refer to ‘short-term’ which was too vague as candidates needed to specify that repayment had to be made in less than 12 months.” “One common mistake was to refer to ‘a short period of time’ without specifying what this meant.”

Worked example 12 marks

Kofi owns Delta Café. At the end of March he owes $3 000 to a coffee supplier, to be paid in April. Define ‘current liability’.

  1. 1

    Knowledge: a debt the business owes [1]

  2. 2

    Knowledge: that must be repaid in less than 12 months [1]

9. Calculating working capital

Working capital is current assets minus current liabilities. Use only these two figures and ignore non-current assets.

Show the working, such as 300 000 − 240 000 for OBZ below. Figures headed $000 are in thousands, so write the answer in full. A bare 60 earns only the method mark.

working capital = current assets - current liabilities

Examiner insight

“Some omitted the millions, which was necessary for the second mark.” “The most common mistake was to calculate the current ratio, which was not the question asked.”

Worked example 12 marks

OBZ uses job production to manufacture carpets. The business has 80 employees. The finance manager knows OBZ needs to manage its cash. She is reviewing OBZ’s financial data. Calculate OBZ’s working capital. Show your working.

Extract from OBZ’s financial data at 30 December 2025($000)
non-current assets800
current assets300
current liabilities240
  1. 1

    working capital = current assets − current liabilities [1]

  2. 2

    = textdollar300 000 - textdollar240 000 = textdollar60 000 [1]

10. Why a business needs working capital

A business needs working capital to pay day-to-day expenses, such as wages, materials, rent and bills. It also needs it for emergencies and unexpected costs.

With enough working capital the business can avoid cash flow problems and keep trading. If it cannot pay its debts it may be forced to close.

In a working capital question, paying wages and paying suppliers are both day-to-day costs. They count as one reason, not two.

Examiner insight

“Common mistakes were to offer different examples of costs such as paying employees and suppliers which could only be awarded once.” “Many candidates provided two examples of expenses which could be paid by a hairdresser. Such answers gained a maximum of 2 marks as they illustrated one reason.”

Worked example 14 marks

OBZ uses job production to manufacture carpets. The business has 80 employees. The finance manager knows OBZ needs to manage its cash. She is reviewing OBZ’s financial data. Outline two reasons why OBZ needs to manage its cash.

Extract from OBZ’s financial data at 30 December 2025($000)
non-current assets800
current assets300
current liabilities240
  1. 1

    Knowledge: to pay wages (labour costs) [1]

  2. 2

    Application: of its 80 employees [1]

  3. 3

    Knowledge: to repay short-term debts [1]

  4. 4

    Application: as it owes $240 000 [1]

11. Applying the importance to the business

A correct answer can still lose marks if it could be about any business. Name the business’s own costs, such as the wages of its employees or the materials it buys.

Then explain why paying them matters. A window cleaner with no cleaning products cannot carry out its work, and this leads to reduced revenue.

Examiner insight

“Weaker candidates needed to fully develop their responses, for example, having explained what working capital can be used for the answer needed to go on to explain the importance to the business.” “Application was limited or not attempted in most responses.”

Worked example 16 marks

Zara owns Spark Window Cleaning. She buys cleaning products every week and drives to her customers in one van. Explain two reasons why Spark needs working capital.

  1. 1

    Knowledge: to pay day-to-day expenses [1]

  2. 2

    Application: cleaning products are bought every week [1]

  3. 3

    Analysis: without products Spark cannot carry out its work, so revenue falls [1]

  4. 4

    Knowledge: to have cash for emergencies or unexpected costs [1]

  5. 5

    Application: for example, a repair if its one van breaks down [1]

  6. 6

    Analysis: the van is repaired at once, so Zara still reaches her customers and no jobs are lost [1]

12. Working capital is not profit or long-term capital

Working capital is not profit. It is not a cash flow forecast either. It is the funds available to pay day-to-day costs.

It is also not start-up capital or long-term capital for buying machinery or paying for an expansion. A lack of working capital is a short-term shortage of funds.

In the question below, the second machine is long-term capital. It is not a reason for needing working capital.

Examiner insight

“A common error was to confuse working capital with profit or a cash flow forecast.” “However, weaker candidates focused on the need for capital in general and incorrectly discussed the need for long term investment to finance the expansion.”

Worked example 14 marks

Mia’s business makes mobile phone covers from plastic on its one machine. Mia wants to expand by buying a second machine next year. Outline two reasons why Mia’s business needs working capital.

  1. 1

    Knowledge: to pay day-to-day expenses [1]

  2. 2

    Application: such as the plastic used to make the phone covers [1]

  3. 3

    Knowledge: to have cash for emergencies or unexpected costs [1]

  4. 4

    Application: such as a repair to its one machine [1]

Recap

  • Working capital is the funds a business uses to pay its day-to-day costs.
  • Working capital = current assets − current liabilities.
  • Current asset: owned or held for less than one year. Current liability: a debt repaid in less than 12 months.
  • It is needed for day-to-day expenses, emergencies and to avoid cash flow problems.
  • Wages and suppliers are one reason: day-to-day costs.
  • Working capital is not profit, not a cash flow forecast and not long-term capital.

End-of-chapter exercise

Test yourself on the whole chapter. Work through these before moving on.

  1. Tolu runs a tailoring business and plans to ask a bank for a loan. Define ‘cash-flow forecast’.2 marks
  2. Identify two cash inflows for Kofi's Bike Repairs.2 marks
  3. Rosa's Rolls expects cash inflow of 30, cash outflow of 35 and an opening balance of 12 in March (all in thousands of dollars). Calculate the closing balance.2 marks
  4. Sana's Sweet Stall sells sweets at a market and has six employees. It uses an old van to carry its stock. Outline two reasons why the stall needs to manage its cash.4 marks
  5. Zuri's Flowers has an incomplete cash-flow forecast (in thousands of dollars). Work out P, Q, R and S. | | January | February | March | | --- | --- | --- | --- | | cash inflow | 40 | 36 | 45 | | cash outflow | 38 | 44 | S | | net cash flow | 2 | P | 5 | | opening balance | 8 | 10 | R | | closing balance | 10 | Q | 7 |4 marks
  6. Greenfield Garden Centre has this cash-flow forecast (in thousands of dollars). Explain what it tells the owner about the garden centre's cash position. | | April | May | June | July | | --- | --- | --- | --- | --- | | net cash flow | (2) | (4) | (5) | 8 | | closing balance | 6 | 2 | (3) | 5 |4 marks
  7. Marlow Motors repairs cars and has a cash shortage in November. It could delay payment to its parts supplier. Explain how this would help.4 marks
  8. Dhillon Printing pays its paper supplier at once, but the schools it prints for pay 45 days after delivery. Its forecast has a negative closing balance in October. Explain two ways it could overcome this problem.6 marks
  9. Pine Ridge Laundry washes bed linen for hotels. Its cash-flow forecast (in thousands of dollars) is in the table. The owner now plans to pay 13 in cash for a new washing machine in May. The machine needs fewer workers, so wages will fall by 2 a month from June. Amend the forecast for May and June. Should Pine Ridge pay for the machine in May? Justify your answer. | | April | May | June | | --- | --- | --- | --- | | cash inflow | 24 | 25 | 26 | | cash outflow | 22 | 23 | 24 | | net cash flow | 2 | 2 | 2 | | opening balance | 4 | 6 | 8 | | closing balance | 6 | 8 | 10 |8 marks
  10. Skyline Couriers delivers parcels for 15 online shops, which pay 60 days after delivery. Its cash-flow forecast (in thousands of dollars) is in the table. Skyline has three options. Option A is an overdraft with a limit of 10. Option B is to delay paying its fuel supplier, so that February's fuel bill of 12 is paid in April. Option C is to ask the shops to pay within 30 days, which would add 20 to cash inflow in March. Recommend the best option. Justify your answer. | | January | February | March | | --- | --- | --- | --- | | cash inflow | 70 | 66 | 78 | | cash outflow | 82 | 80 | 87 | | net cash flow | (12) | (14) | (9) | | opening balance | 20 | 8 | (6) | | closing balance | 8 | (6) | (15) |12 marks
  11. Omar owns a taxi firm. He pays for fuel every day and his drivers’ wages every week. Define ‘working capital’.2 marks
  12. Sunita’s flower shop owes $800 to a grower, to be paid next month. Define ‘current liabilities’.2 marks
  13. Tru’s Toys has current assets of textdollar45 000 and current liabilities of textdollar30 000. Calculate its working capital. Show your working.2 marks
  14. An extract from the financial data of Dara’s Plumbing, in $000, gives non-current assets 400, current assets 120, current liabilities 85 and non-current liabilities 150. Calculate its working capital. Show your working.2 marks
  15. Kofi’s Café pays two staff each week, buys coffee beans from a supplier and has one coffee machine. Outline two reasons why Kofi’s Café needs working capital.4 marks
  16. Pedro’s Garage has current assets of textdollar18 000 and current liabilities of textdollar12 000. Pedro says, ‘The difference is our profit, so I can take it out of the business.’ Calculate the working capital and outline why Pedro is wrong.4 marks
  17. Ayo’s Dry Cleaners has 12 staff who are paid every week. Explain one reason why working capital is important to Ayo’s Dry Cleaners.4 marks
  18. Lena runs a new bakery that makes wedding cakes in one oven. She buys flour and eggs each week and pays rent each month. Explain two reasons why Lena’s bakery needs working capital.6 marks
  19. Nadia owns Harbour Kayaks, which hires kayaks to tourists. An extract from its financial data, in $000, gives current assets 14 and current liabilities 11. Nadia pays four workers every week. In winter there are few tourists. She plans to open a second site next year. Explain four reasons why working capital is important to Harbour Kayaks.8 marks
  20. Rina’s Print Shop prints posters for local businesses and has three employees. Its current assets are textdollar24 000, of which textdollar15 000 is cash. Its current liabilities are textdollar10 000. A new printer costs textdollar15 000 and would let the shop take larger orders. Rina can pay for the printer in cash now, or keep the cash and not buy the printer this year. Which option should Rina choose? Justify your answer.12 marks

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