Why is "Treating cash flow and profit as the same thing." a common mistake in Cash flow?

Why it happens: Both involve money, so students assume a profitable business automatically has cash and cannot fail. How to avoid it: Remember profit is revenue − costs over a period, while cash flow is actual money in and out day to day. State explicitly that a profitable firm can still be illiquid and go insolvent. Source: IB Diploma Programme Business Management Guide (first assessment 2024)

Why is "Forgetting that the closing balance carries forward as the next month's opening balance." a common mistake in Cash flow?

Why it happens: Students calculate each month in isolation, or reset the opening balance to the original starting figure every month. How to avoid it: Always set each opening balance equal to the previous month's closing balance. Draw an arrow linking closing → next opening as you work down the forecast. Source: IB Diploma Programme Business Management Guide (first assessment 2024)

Why is "Recommending a generic 'get a loan' instead of a solution matched to the specific problem." a common mistake in Cash flow?

Why it happens: A loan feels like an all-purpose fix, so students reach for it without diagnosing the actual cause or duration of the shortage. How to avoid it: Diagnose the cause first (slow debtors? overstocking? a short-term gap?), then match the solution — factoring/tighter credit for slow debtors, overdraft/extended credit for a short gap, reducing stock for overstocking. Source: IB Diploma Programme Business Management Guide (first assessment 2024)

Why is "Mishandling negative figures — dropping the minus sign or mis-adding a deficit." a common mistake in Cash flow?

Why it happens: Forecast negatives are shown in brackets, and adding a negative net cash flow to a balance confuses students under time pressure. How to avoid it: Treat brackets as a minus. Closing = opening + net cash flow, so a −4,000 net cash flow REDUCES the balance: 1,000 + (−4,000) = −3,000. Source: IB Diploma Programme Business Management Guide (first assessment 2024)

Why is "Confusing depreciation or credit sales as cash movements in a forecast." a common mistake in Cash flow?

Why it happens: These items affect profit, so students wrongly enter them as cash inflows or outflows. How to avoid it: Only enter actual cash movements. Depreciation is a non-cash expense (never in a forecast); a credit sale enters the forecast only when the customer's cash is received, not when the sale is made. Source: IB Diploma Programme Business Management Guide (first assessment 2024)

Why is "In evaluation questions, listing solutions without weighing trade-offs or reaching a judgement." a common mistake in Cash flow?

Why it happens: Students describe several solutions to show knowledge but stop short of the AO3 skills of comparison and conclusion. How to avoid it: For ~10-mark questions, weigh cost, speed, risk and side-effects, compare against an alternative, and give a conditional conclusion ('the best solution is X, provided Y'). Source: IB Diploma Programme Business Management Guide (first assessment 2024)

IB DP Business Management (147712)

Cash flow

0% Complete

Detailed Study Notes

Detailed notes on Finance and Accounts for IB DP Business Management, covering key concepts, explanations, examples, and exam-focused revision points.

Cash flow — the money moving in and out that keeps a business alive, and why it is not the same as profit

Cash is the lifeblood of a business: profit is worked out over a year, but bills, wages and suppliers must be paid every week from actual cash. This subtopic shows why a profitable business can still collapse from a cash-flow crisis (illiquidity), how to build and read a cash-flow forecast (receipts, payments, net cash flow, opening and closing balance), what causes cash-flow problems (overtrading, too much stock, over-generous customer credit, seasonal demand, poor sales) and — the examined skill — how to recommend a SPECIFIC solution matched to the specific problem (debt factoring, sale and leaseback, extended trade credit, an overdraft, cutting stock, tightening customer credit).

At a glance

Cash flow = the movement of cash INTO (inflows/receipts) and OUT OF (outflows/payments) a business over time.
Cash flow ≠ profit: a business can be profitable on paper yet run out of cash and fail (illiquidity/insolvency).
Net cash flow = total cash inflows − total cash outflows for a period.
Closing balance = opening balance + net cash flow; that closing balance becomes NEXT period's opening balance.
Common causes of cash-flow problems: overtrading, too much stock, giving customers too much credit, seasonal demand, poor sales, one-off large payments.
Solutions must be MATCHED to the cause: debt factoring or tighter credit for slow-paying customers; sale and leaseback or an overdraft for a short-term gap; reducing stock for overstocking.
Working capital (current assets − current liabilities) is the day-to-day money that keeps the business liquid.
Command terms: Define/State/Complete a line (AO1, 2m), Calculate/Explain (AO2, 4–6m), Recommend/Evaluate (AO3, ~10m). Paper 2 is heavily quantitative.

What you’ll learn

Mapped to the IB DP Business Management subject guide (2024 onwards (first assessment May 2024)).

Distinguish cash flow from profit and explain why a profitable business can still fail from a cash-flow crisis.
Construct a cash-flow forecast, calculating net cash flow, opening balance and closing balance for each period.
Interpret a cash-flow forecast to identify when and why a business faces a cash shortage.
Explain the main causes of cash-flow problems.
Recommend and justify a specific solution matched to the specific cash-flow problem identified.
Explain the role of working capital in maintaining liquidity.

Cash flow is not profit

Profit is revenue minus costs measured over a whole period; cash flow is actual money moving in and out day to day. A business can be profitable and still fail because it has no cash to pay bills on time.

Cash flow is the movement of cash into and out of a business over a period of time. Profit is what is left when total costs are subtracted from total revenue over an accounting period. They are not the same thing, and confusing them is the classic examiner trap.

A business can be profitable but illiquid — it makes a profit on paper yet has no cash in the bank to pay wages, suppliers or the tax bill this week. When a firm cannot pay its short-term debts it is insolvent, and insolvency — not a lack of profit — is what forces most businesses to close.

Why do cash flow and profit differ?

Credit sales — a sale is recorded as revenue (and profit) the moment goods are delivered, but the cash may not arrive for 30, 60 or 90 days. Profit rises today; cash arrives later.
Buying fixed assets — paying cash for machinery or vehicles is a large cash outflow now, but it is not counted as a cost against profit all at once (it is spread as depreciation).
Depreciation — an expense that reduces profit but involves no cash outflow at all; the cash left the business when the asset was first bought.
Buying stock/inventory — cash goes out to buy stock now, but it only becomes a cost (cost of sales) when the stock is actually sold.
Loan repayments — the capital repaid is a cash outflow but is not an expense on the profit calculation (only the interest is).

The takeaway: profit is an opinion measured over time; cash is a fact measured day to day. Managers must watch both.

Profit = revenue − costs over a period; cash flow = cash in − cash out over time.
Profitable ≠ liquid: firms fail from running out of CASH, not from a lack of profit.
Credit sales, buying assets/stock and depreciation all break the link between profit and cash.

The cash-flow forecast

A cash-flow forecast predicts cash receipts and payments month by month. It calculates net cash flow, then adds it to the opening balance to give the closing balance — which carries forward as next month's opening balance.

A cash-flow forecast is a prediction of the cash a business expects to flow in and out over future periods (usually monthly). It is a planning tool: it warns managers in advance when cash will run short so they can act early — arrange an overdraft, delay a purchase or chase debtors.

The forecast is built from four running lines:

Cash inflows (receipts) — cash actually received: cash sales, cash from credit customers (debtors) paying up, loans received, capital injected, asset sales.
Cash outflows (payments) — cash actually paid out: raw materials, wages, rent, utilities, loan repayments, purchase of equipment, tax.
Net cash flow = total inflows − total outflows for the month. It is positive (a surplus) or negative (a deficit).
Opening balance = the cash the business starts the month with. Closing balance = opening balance + net cash flow. Crucially, this month's closing balance becomes next month's opening balance — the balance carries forward.

Worked mini-forecast — Kiran's Kites (a seasonal retailer), opening January with $5,000:

($)	January	February	March
Cash inflows (receipts)	20,000	18,000	30,000
Cash outflows (payments)	24,000	22,000	25,000
Net cash flow	(4,000)	(4,000)	5,000
Opening balance	5,000	1,000	(3,000)
Closing balance	1,000	(3,000)	2,000

Read it: January net cash flow = 20,000 − 24,000 = −4,000, so closing = 5,000 + (−4,000) = 1,000. February opens with that 1,000, another −4,000 pushes the closing to −3,000 (shown in brackets = overdrawn). March's strong receipts recover the balance to +2,000. Brackets ( ) conventionally mean a negative figure.

The forecast instantly flags February as the danger month: the business is overdrawn by $3,000 and needs a solution before then.

Four lines: inflows (receipts), outflows (payments), net cash flow, opening/closing balance.
Net cash flow = inflows − outflows; can be positive (surplus) or negative (deficit).
Closing balance = opening balance + net cash flow.
Closing balance carries forward as next month's opening balance — always link the months.
A negative closing balance (in brackets) means the business is overdrawn and needs finance.

See the full worked example for cash flow →

Visualising the running balance

Plotting the closing balance month by month shows exactly when a business dips below zero and needs finance. Below, Kiran's Kites' balance falls into overdraft in February before recovering in March.

A cash-flow forecast is easier to read as a picture. The chart below tracks Kiran's Kites' closing balance across the three months. When the line drops below the zero axis, the business is overdrawn and must have finance arranged.

The dip below the zero line in February is the signal to act. Managers would arrange an overdraft facility, bring forward March's receipts (chase debtors) or delay some February payments so the line never crosses into the red.

Plotting the closing balance reveals the exact month a business runs short.
Any point below the zero axis = overdrawn = finance must be arranged in advance.
The forecast's value is early warning — it buys time to fix the gap before it happens.

Causes of cash-flow problems

Cash-flow problems arise from growing too fast (overtrading), holding too much stock, giving customers too much credit, seasonal demand, poor sales or one-off large payments. Identifying the exact cause is what makes a solution defensible.

A cash-flow problem is a shortage of cash to meet payments as they fall due, even where the business may be profitable. The main causes:

Overtrading — expanding too fast: the firm takes on more orders than its working capital can support, pouring cash into stock, wages and materials before customers pay. A very common cause for fast-growing firms.
Holding too much stock — cash is tied up in inventory sitting in the warehouse, unsold, instead of being available to pay bills.
Giving customers too much credit — generous or poorly-controlled trade credit (long payment terms, slow-paying debtors) delays cash inflows while payments still go out.
Seasonal demand — sales cluster in a few months (e.g. retailers before a festival, tourism in summer), leaving lean months where outflows exceed inflows.
Poor or falling sales — weak demand, new competition or recession cut cash inflows below the level needed to cover fixed outflows.
Large one-off payments — a tax bill, loan repayment, or buying an expensive fixed asset all at once drains the cash balance.
Overinvesting in fixed assets — spending too much cash on machinery or premises leaves too little working capital.

In the exam, the recommendation only scores well if it is matched to the specific cause identified in the stimulus. Diagnose first (e.g. 'the problem is slow-paying debtors'), then prescribe the matching cure.

Overtrading — growing faster than working capital allows.
Too much stock, or customers given too much/too-slow credit.
Seasonal or falling demand; large one-off payments; overinvesting in fixed assets.
Diagnose the exact cause before choosing a solution.

Solutions — matched to the problem

Each cash-flow fix suits a different problem: debt factoring or tighter credit for slow debtors; sale and leaseback or an overdraft for a short-term gap; reducing stock for overstocking; extended supplier credit to delay outflows. Match the cure to the cause.

The examined skill is recommending a specific solution matched to the specific problem — not a generic 'get a loan'. The main solutions:

Debt factoring — sell the business's unpaid invoices (debtors) to a factoring company, which pays ~80–90% of their value immediately. Best when the problem is slow-paying customers — it converts future receipts into cash now. Cost: the factor keeps a fee, so the business receives less than the full invoice value.
Sale and leaseback — sell a fixed asset (e.g. premises or vehicles) to raise a lump of cash, then lease it back and keep using it. Best for a one-off need to raise cash while retaining use of the asset. Downside: loses ownership and pays rent long-term.
Arranging an overdraft — an agreed facility to withdraw more than the account holds, up to a limit. Best for a short-term, temporary gap (like February in the forecast). Flexible — interest only on the amount used — but high interest and repayable on demand.
Negotiating extended trade credit — persuade suppliers to allow longer to pay (e.g. 30 → 60 days). Delays cash outflows to align with inflows. Risk: may lose early-payment discounts or strain supplier goodwill.
Tightening customer credit — reduce credit periods, credit-check customers, offer discounts for early payment. Speeds up cash inflows where over-generous credit is the cause. Risk: customers may switch to competitors offering easier terms.
Reducing stock levels — sell off or hold less inventory (e.g. just-in-time) to release the cash tied up. Best where overstocking is the cause. Risk: stock-outs and lost sales if demand jumps.
Short-term borrowing / loan — a last resort for a genuine long-term shortfall; increases interest costs and is slow to arrange, so it is rarely the best match for a temporary gap.

Evaluation (AO3): weigh cost, speed, risk and side-effects, and judge which fits this firm's cause, size and situation. For a temporary seasonal dip, an overdraft usually beats a long-term loan; for chronic slow debtors, factoring or tighter credit beats an overdraft that only masks the symptom.

Slow-paying debtors → debt factoring or tighten customer credit.
Short-term temporary gap → overdraft or extended trade credit.
One-off need to raise cash → sale and leaseback.
Overstocking → reduce stock levels.
Always justify the choice against the specific cause, cost, speed and risk.

Working capital management

Working capital (current assets − current liabilities) is the cash and near-cash a business uses to fund day-to-day operations. Managing debtors, creditors and stock keeps a firm liquid and prevents cash-flow crises.

Working capital is the finance available for the day-to-day running of a business:

Working capital = current assets − current liabilities

Current assets are cash and items that will turn into cash within a year (cash, debtors/receivables, stock). Current liabilities are debts due within a year (creditors/payables, overdraft, short-term loans, tax due).

Positive working capital means current assets exceed current liabilities — the firm can comfortably meet short-term debts (it is liquid).
Too little working capital risks insolvency — the firm cannot pay bills as they fall due.
Too much working capital (idle cash, excess stock, over-generous debtors) is inefficient — that cash could be earning a return elsewhere.

Managing the working-capital cycle — the time between paying for stock and receiving cash from customers — is central to good cash flow. Managers shorten it by collecting from debtors faster, holding less stock, and taking longer (reasonable) credit from suppliers. Good working-capital management is the day-to-day habit that prevents the cash-flow crises this whole subtopic is about.

Working capital = current assets − current liabilities.
Positive working capital = liquid; too little = insolvency risk; too much = inefficient.
Shorten the working-capital cycle: collect debtors faster, hold less stock, take reasonable supplier credit.

See the full worked example for cash flow →

Quick recap

Cash flow is the movement of cash in and out over time; it is NOT the same as profit — a profitable business can still fail from illiquidity.
Net cash flow = inflows − outflows; closing balance = opening balance + net cash flow; the closing balance carries forward as next month's opening balance.
A cash-flow forecast gives early warning of when cash will run short so managers can act in advance.
Causes include overtrading, too much stock, over-generous customer credit, seasonal or poor sales, and large one-off payments.
Solutions must be matched to the cause: factoring/tighter credit for slow debtors, overdraft/extended trade credit for a short gap, sale and leaseback for a one-off need, reducing stock for overstocking.
Working capital (current assets − current liabilities) is the day-to-day money that keeps a firm liquid.

Memorise this

Verbatim phrases, formulae and definitions IB DP mark schemes credit (key for AO1 knowledge marks on Paper 1).

Net cash flow = total cash inflows − total cash outflows.
Closing balance = opening balance + net cash flow.
Opening balance = previous month's closing balance (it carries forward).
Working capital = current assets − current liabilities.
Cash flow ≠ profit — profitable firms can still go insolvent.
Match the solution to the cause AND the duration of the shortfall.

How it’s examined

Paper 2 is heavily quantitative on this subtopic. AO1 (2 marks): define a term or complete/state a single forecast line (e.g. a missing net cash flow or closing balance). AO2 (4–6 marks): construct or complete a full forecast and interpret it — calculate net cash flow, opening and closing balances, then explain what the figures show. AO3 (~10 marks): recommend and justify a specific solution to a stated cash-flow problem, or evaluate whether a business's cash-flow position is sustainable — you must diagnose the cause, match a solution to it, weigh cost/speed/risk, and reach a supported judgement. Show all working in calculations; use brackets for negatives; always carry the closing balance forward as the next opening balance.

Sources: IB Diploma Programme Business Management Guide (first teaching 2022, first assessment 2024). Last reviewed 2026-07-24.

Take this whole topic with you

Step-by-step worked examples — Cash flow

Step-by-step solutions to past-paper-style questions on cash flow, written exactly the way a tutor would explain them at the board.

1Calculating net cash flow for a month
Getting started• net cash flow, AO2, calculation
Question
In April, a café receives $18,500 in cash from sales and pays out$ 15,200 in wages, rent and supplies. Calculate the net cash flow for April. [2]
Step-by-step solution
1. Step 1
  Net cash flow = total cash inflows − total cash outflows for the period.
  $Net cash flow = 18,500 - 15,200$
2. Step 2
  Subtract to find the surplus. The result is positive, so the café generated more cash than it spent in April.
  $Net cash flow = 3,300$
Answer
Net cash flow for April = +$3,300 (a cash surplus).
Examiner tip
State the sign/meaning, not just the number — a positive net cash flow is a surplus. Always show the subtraction for the method mark.
2Finding the closing balance
Getting started• closing balance, AO2, calculation
Question
A business starts May with an opening balance of $2,000. Its net cash flow for May is −$ 3,500. Calculate the closing balance for May. [2]
Step-by-step solution
1. Step 1
  Closing balance = opening balance + net cash flow.
  $Closing balance = 2,000 + (-3,500)$
2. Step 2
  Adding a negative net cash flow reduces the balance below zero — the business is overdrawn by $1,500.
  $Closing balance = -1,500$
Answer
Closing balance for May = −$1,500 (overdrawn); shown in a forecast as (1,500).
Examiner tip
A negative closing balance is written in brackets and means the account is overdrawn. Do not drop the minus sign.
3Completing a missing forecast line
Getting started• forecast, AO1, calculation
Question
A forecast shows: cash inflows $12,000; net cash flow −$ 2,000. State the figure for total cash outflows. [2]
Step-by-step solution
1. Step 1
  Rearrange net cash flow = inflows − outflows, so outflows = inflows − net cash flow.
  $Outflows = 12,000 - (-2,000)$
2. Step 2
  Subtracting a negative is the same as adding, so outflows exceed inflows by $2,000.
  $Outflows = 14,000$
Answer
Total cash outflows = $14,000.
Examiner tip
Watch the double-negative: outflows = 12,000 − (−2,000) = 14,000. If outflows only equalled inflows, net cash flow would be zero.
4Building a full three-month forecast
Building confidence• forecast, AO2, calculation, closing balance
Question
Kiran's Kites opens January with $5,000. Forecast receipts and payments are: Jan 20,000 in / 24,000 out; Feb 18,000 in / 22,000 out; Mar 30,000 in / 25,000 out. Complete the forecast, calculating net cash flow, opening and closing balance for each month. [6]
Step-by-step solution
1. Step 1
  January net cash flow = inflows − outflows.
  $20,000 - 24,000 = -4,000$
2. Step 2
  January closing = opening + net cash flow = 5,000 + (−4,000).
  $5,000 + (-4,000) = 1,000$
3. Step 3
  February opening balance = January closing balance (it carries forward). February net cash flow = 18,000 − 22,000.
  $18,000 - 22,000 = -4,000 ; opening = 1,000$
4. Step 4
  February closing = 1,000 + (−4,000) — the business is now overdrawn.
  $1,000 + (-4,000) = -3,000$
5. Step 5
  March opening = February closing = −3,000. March net cash flow = 30,000 − 25,000 = +5,000.
  $30,000 - 25,000 = 5,000 ; opening = -3,000$
6. Step 6
  March closing = −3,000 + 5,000 = +2,000 — the balance recovers.
  $-3,000 + 5,000 = 2,000$
Answer
Net cash flow: Jan −4,000, Feb −4,000, Mar +5,000. Opening: Jan 5,000, Feb 1,000, Mar (3,000). Closing: Jan 1,000, Feb (3,000), Mar 2,000.
Examiner tip
Full marks require the closing balance to carry forward correctly as each next opening balance. Losing the carry-forward is the single most common Paper 2 error.
5Interpreting the forecast — when and why cash runs short
Building confidence• forecast, AO2, interpretation
Question
Using Kiran's Kites' completed forecast (Jan closing 1,000; Feb closing (3,000); Mar closing 2,000), identify the month the business faces a cash-flow problem and explain why. [4]
Step-by-step solution
1. Step 1
  Scan the closing balances for any negative figure — February's closing balance is (3,000), i.e. −$3,000.
2. Step 2
  A negative closing balance means the business is overdrawn: it cannot pay its bills from its own cash in February.
3. Step 3
  Why: for two months running, outflows ( $24,000 then$ 22,000) exceeded inflows ( $20,000 then$ 18,000). The negative net cash flows drained the small opening balance and pushed it below zero — a sign of seasonal low sales before the March upturn.
Answer
February is the problem month — the closing balance is −$3,000 (overdrawn). Two consecutive negative net cash flows exhausted the opening cash. The business must arrange finance (e.g. an overdraft) BEFORE February.
Examiner tip
Interpretation must go beyond spotting the negative figure — link it to the underlying cause (outflows exceeding inflows in low-season months) and state the implication (needs finance in advance).
6Calculating and interpreting working capital
Building confidence• working capital, AO2, liquidity
Question
A firm has cash $4,000, debtors$ 9,000 and stock $12,000. Its creditors are$ 16,000 and it has a short-term loan of $5,000 due within the year. Calculate its working capital and comment on its liquidity. [5]
Step-by-step solution
1. Step 1
  Current assets = cash + debtors + stock (all turn into cash within a year).
  $Current assets = 4,000 + 9,000 + 12,000 = 25,000$
2. Step 2
  Current liabilities = creditors + short-term loan (both due within a year).
  $Current liabilities = 16,000 + 5,000 = 21,000$
3. Step 3
  Working capital = current assets − current liabilities.
  $Working capital = 25,000 - 21,000 = 4,000$
4. Step 4
  Working capital is positive (+ $4,000), so the firm can cover its short-term debts — but the margin is thin, and$ 12,000 of the assets is stock (less liquid than cash), so it should watch its liquidity.
Answer
Working capital = +$4,000. The firm is liquid but only marginally; much of its current assets is tied up in stock, so a slow month could quickly create a cash-flow problem.
Examiner tip
A positive figure alone is not enough for the interpretation marks — comment on the quality (how much is cash vs stock) and the size of the safety margin.
7Testing a solution — the effect of an overdraft/extended credit
Stretch• forecast, AO3, solutions, calculation
Question
To fix February's − $3,000 closing balance, Kiran's Kites negotiates to delay$ 5,000 of February's payments to March. Recalculate February and March closing balances (Jan closing = 1,000; original Feb 18,000 in / 22,000 out; Mar 30,000 in / 25,000 out) and assess whether this solves the problem. [8]
Step-by-step solution
1. Step 1
  Revised February outflows = 22,000 − 5,000 = 17,000 (the $5,000 is deferred).
  $Feb net cash flow = 18,000 - 17,000 = 1,000$
2. Step 2
  February closing = opening 1,000 + net 1,000.
  $Feb closing = 1,000 + 1,000 = 2,000$
3. Step 3
  February is no longer overdrawn (+2,000). Now March opening = 2,000, and March outflows rise by the deferred 5,000 → 30,000.
  $Mar net cash flow = 30,000 - 30,000 = 0$
4. Step 4
  March closing = opening 2,000 + net 0.
  $Mar closing = 2,000 + 0 = 2,000$
5. Step 5
  Assess: the deferral removes the February overdraft (the immediate crisis) and the business stays positive across all months. Because March had a strong surplus, it can absorb the extra $5,000 without going negative — so this is a well-matched, low-cost fix. Risk: it relies on suppliers agreeing, and March's cushion is now gone.
Answer
Revised closing balances: Feb + $2,000, Mar +$ 2,000. Deferring the payment removes the February overdraft and no month goes negative, so it solves the short-term timing problem — provided suppliers agree and March demand holds.
Examiner tip
Strong answers recalculate accurately AND evaluate — noting the fix works only because March had a surplus to absorb the delayed payment, and that it depends on supplier goodwill.
8Overtrading and debt factoring — a numeric check
Stretch• debt factoring, overtrading, AO3, calculation
Question
A fast-growing firm has $50,000 of unpaid customer invoices but only$ 2,000 cash, and must pay $18,000 in wages next week. A factor offers to advance 85% of the invoice value immediately for a 4% fee on the total. Calculate the cash raised and explain whether factoring solves the immediate problem. [8]
Step-by-step solution
1. Step 1
  Cash advanced now = 85% of the $50,000 invoices.
  $Advance = 0.85 x 50,000 = 42,500$
2. Step 2
  The factor's fee = 4% of the $50,000 total, which reduces what the firm ultimately keeps.
  $Fee = 0.04 x 50,000 = 2,000$
3. Step 3
  Immediate cash position = existing cash + advance = 2,000 + 42,500 = 44,500, comfortably above the $18,000 wage bill.
  $Cash available = 2,000 + 42,500 = 44,500$
4. Step 4
  Judgement: the diagnosis is overtrading — cash is trapped in debtors while the firm grows. Factoring is well-matched because it converts those debtors into cash NOW, easily covering wages. Cost: the $2,000 fee (plus the 15% held back until customers pay), so the firm receives less than the full invoice value.
Answer
Cash advanced = $42,500; total available =$ 44,500, more than enough for the $18,000 wages. Factoring solves the immediate cash-flow problem caused by overtrading, at a cost of the$ 2,000 fee and reduced margin.
Examiner tip
Match the tool to the cause: factoring targets cash tied up in debtors (typical of overtrading). Reward candidates who note the cost of the fee and that it is not free finance.
9Choosing between two solutions
Stretch• solutions, overdraft, AO3, evaluation
Question
A seasonal firm faces a predictable two-month cash gap of about $10,000 each summer. It is choosing between (A) a 5-year bank loan of$ 60,000 at 8% and (B) an agreed overdraft facility of $15,000, interest charged only on the amount used. Recommend which better fits the problem and justify. [10]
Step-by-step solution
1. Step 1
  Diagnose the problem: the gap is TEMPORARY and RECURRING (two months a year), not a permanent shortage. The right finance should be short-term and flexible.
2. Step 2
  Option A (loan): borrowing $60,000 for 5 years means paying interest on the full amount all year round (roughly 0.08 × 60,000 =$ 4,800/year) even though the firm only needs ~$10,000 for two months. It is over-sized and expensive for the need.
3. Step 3
  Option B (overdraft): interest is charged only on what is drawn, only during the two months it is used, so the cost is far lower and matched to the duration of the gap. It is flexible and quick to use.
4. Step 4
  Weigh the trade-off: the overdraft is repayable on demand and carries a higher headline interest rate, but because the borrowing is small and brief, the total cost is much lower and it fits the recurring seasonal pattern. The loan only makes sense for a long-term investment, which this is not.
Answer
Recommend the overdraft (Option B). The problem is a small, temporary, recurring seasonal gap; an overdraft charges interest only when used, so it is far cheaper and better matched than a 5-year loan sized for a permanent need. The loan would leave the firm paying interest on $60,000 year-round for a$ 10,000 two-month shortfall.
Examiner tip
AO3 marks come from matching the solution to the DURATION and size of the problem and justifying against the alternative — not from listing generic pros and cons of each source.

Model Answers — Cash flow

High-scoring sample answers for cash flow on the Cambridge IGCSE paper, with examiner-style notes mapping each response to the mark scheme and assessment objectives.

Question 1
2 marks
Define the term 'cash flow'. [2]
Model answer
Cash flow is the movement of cash into (inflows/receipts) and out of (outflows/payments) a business over a period of time. It measures actual money entering and leaving the business, as distinct from profit.
Why this scores
2 marks: 1 for the idea of cash moving in and out, 1 for 'over a period of time' or contrasting it with profit. A one-word or vague answer caps at 1 mark.
Question 2
2 marks
State the formula for net cash flow. [2]
Model answer
Net cash flow = total cash inflows − total cash outflows for a period. A positive figure is a cash surplus; a negative figure is a cash deficit.
Why this scores
Both elements (inflows and outflows subtracted) are needed for full marks. Naming the sign convention (surplus/deficit) confirms understanding.
Question 3
2 marks
State one reason why a profitable business might still have a cash-flow problem. [2]
Model answer
It may make credit sales — profit is recorded when the goods are sold, but the cash is not received until customers pay (e.g. 60 days later). So the business can show a profit while having no cash in the bank to pay this month's bills.
Why this scores
1 mark for a valid reason (credit sales, buying fixed assets, holding stock, large loan repayment), 1 for developing it to show why cash is short. Accept any one correct, developed reason.
Question 4
4 marks
Explain how a cash-flow forecast can help a business avoid a liquidity crisis. [4]
Model answer
A cash-flow forecast predicts each month's cash inflows, outflows, net cash flow and closing balance in advance. By showing when the closing balance is likely to turn negative (overdrawn), it gives managers early warning of a shortage — for example, flagging that a seasonal firm will run out of cash in February. With that warning, managers can act before the crisis hits: arrange an overdraft, delay a large purchase, chase debtors to bring cash in sooner, or negotiate longer credit from suppliers. This planning turns a potential liquidity crisis into a manageable, anticipated dip, protecting the business from being unable to pay wages or suppliers.
Why this scores
AO2, 4 marks: 2 for explaining what the forecast reveals (timing of a shortage via the closing balance), 2 for how that enables pre-emptive action. Application to a context (e.g. seasonal firm) strengthens the response.
Question 5
4 marks
A retailer's February forecast shows opening balance $1,000, receipts$ 18,000 and payments $22,000. Calculate the closing balance and explain what it means for the business. [4]
Model answer
Net cash flow = 18,000 − 22,000 = − $4,000. Closing balance = opening balance + net cash flow = 1,000 + (−4,000) = −$ 3,000. The closing balance is negative, meaning the retailer is overdrawn by $3,000 in February — it does not have enough cash to cover its payments and must arrange finance (such as an overdraft). This figure also carries forward as March's opening balance, so unless March generates a surplus, the problem will continue.
Why this scores
AO2, 4 marks: 1 for net cash flow, 1 for the closing balance (−3,000), 2 for interpretation (overdrawn, needs finance, carries forward). Award method marks even if the final figure has a slip.
Question 6
6 marks
Explain two causes of cash-flow problems for a rapidly expanding business. [6]
Model answer
First, overtrading: as the business wins more orders, it must pay upfront for extra raw materials, stock and wages long before customers pay for the finished goods. Its working capital cannot keep pace with the growth, so cash drains out faster than it comes in — a very common cause for fast-growing firms. Second, giving customers too much credit: to win the larger orders that fuel expansion, the firm may offer generous payment terms (e.g. 60–90 days). Sales and profit rise on paper, but the cash inflows are delayed, while suppliers, staff and rent still have to be paid immediately. Both causes share the same mechanism — cash outflows occur before the matching inflows arrive — which is why a growing, profitable business can still be short of cash.
Why this scores
AO2, 6 marks: up to 3 per cause (identify + explain + apply to an expanding firm). A generic list of causes without explanation of WHY cash falls short caps in the middle band.
Question 7
10 marks
A business has a cash-flow problem caused mainly by customers who take too long to pay their invoices. Recommend a solution to this problem. [10]
Model answer
The diagnosed cause is slow-paying debtors: cash is tied up in unpaid invoices while the business still has to meet its own outflows, so the fix must speed up cash inflows from customers. The best-matched solution is debt factoring (supported by tightening customer credit for the future). With factoring, the business sells its unpaid invoices to a factor that advances around 80–90% of their value immediately, converting future receipts into cash now — directly attacking the cause. For example, $50,000 of invoices could release roughly$ 42,500 straight away, comfortably covering wages and suppliers.

The main drawback is cost: the factor charges a fee, so the business receives less than the full invoice value, reducing its profit margin. It may also signal to customers that the firm is short of cash. An alternative, an overdraft, would cover the gap but only masks the symptom — the debtors are still slow, so the problem recurs each month and interest keeps accruing. Simply 'taking out a loan' would be the wrong match: it adds long-term debt and interest for what is a working-capital timing problem, not a long-term investment need.

On balance, factoring is the strongest immediate solution because it targets the actual cause (cash trapped in debtors) and delivers cash fast. To make it sustainable rather than a one-off, the business should also tighten its credit control — credit-check customers, shorten payment terms and offer early-payment discounts — so future invoices are paid faster and the reliance on factoring falls. The final judgement therefore depends on the fee being affordable relative to the cost of running out of cash: for a firm facing an imminent shortage, paying the factor's fee is clearly worth it, provided it fixes the underlying credit control alongside.
Why this scores
AO3, 10 marks: reward a solution MATCHED to the stated cause (factoring/tighter credit for slow debtors), a balanced weighing of drawbacks and an alternative, and a justified conclusion. Recommending a generic loan or an unmatched solution caps in the lower bands — matching to the cause is the discriminator.
Question 8
10 marks
Evaluate the use of sale and leaseback as a solution to a one-off cash-flow shortage. [10]
Model answer
Sale and leaseback means selling a fixed asset the business owns — such as its premises or delivery vehicles — to raise a lump sum of cash, then leasing the asset back so it can keep using it. As a solution to a one-off, sizeable cash shortage it has clear strengths: it releases a large amount of cash quickly without giving up the use of the asset or diluting ownership through new shares, and it avoids taking on a conventional long-term loan. If, say, a firm needs to cover a major tax bill or a temporary loss of a big customer, selling its building could raise far more than an overdraft would allow.

However, there are serious drawbacks. The business permanently loses ownership of the asset, so it forgoes any future rise in its value and must now pay rent indefinitely — a new fixed outflow that could itself strain cash flow in future. It is also slow to arrange compared with an overdraft, so it suits a foreseen one-off need rather than a sudden emergency. And it is only available to firms that own suitable assets in the first place.

Whether it is the best solution depends on the nature of the shortage. For a genuinely one-off, large need where the firm owns valuable assets and wants to avoid new borrowing, sale and leaseback can be ideal — it matches the size and one-off character of the problem. But for a small, temporary, recurring gap (such as a seasonal dip), it is disproportionate and expensive: an overdraft or extended trade credit would be cheaper and quicker. The key judgement is matching the solution to the size and duration of the problem: sale and leaseback fits large, one-off needs, not routine timing gaps.
Why this scores
AO3, 10 marks: needs balanced evaluation (benefits vs the permanent loss of ownership and ongoing rent) AND a judgement that conditions the answer on the type of shortage. Top-band answers stress matching the solution to the size/duration of the problem.
Question 9
10 marks
A profitable manufacturer is forecasting a negative closing balance for the next three months. Recommend how it could improve its cash flow. [10]
Model answer
That a profitable firm still forecasts negative closing balances confirms the classic point that profit and cash are different: cash is likely trapped in stock and debtors, or being drained by large payments, faster than it flows back in. The remedy should therefore free up or bring forward cash without harming the profitable core business.

The strongest immediate levers are working-capital measures matched to where the cash is stuck. If much of the cash is tied up in stock, reducing inventory (moving toward just-in-time ordering) releases cash quickly, though it risks stock-outs if demand jumps. If the cause is slow debtors, tightening customer credit and/or debt factoring speeds inflows, at the cost of possibly losing some price-sensitive customers or paying a factor's fee. To smooth the timing of outflows, the firm could negotiate extended trade credit from suppliers so its own payments align better with receipts — cheap and quick, but dependent on supplier goodwill. For the residual short-term gap in the three months, an agreed overdraft is the flexible, low-commitment backstop, with interest charged only on the amount actually used.

Evaluation: because the business is profitable, its problem is timing, not viability, so it should avoid over-reacting with expensive long-term borrowing. The best package is a combination — reduce stock and tighten credit to attack the root cause, negotiate supplier credit to smooth timing, and hold an overdraft to cover the remaining dip. The recommendation depends on why the cash is short: the firm must first identify whether stock, debtors or a one-off payment is the main culprit, then apply the matching measure. Applied together and monitored via an updated forecast, these should restore positive closing balances without damaging the profitable operations.
Why this scores
AO3, 10 marks: reward recognition that profit ≠ cash, solutions matched to where cash is trapped (stock/debtors/timing), balanced trade-offs, and a conditional, justified conclusion. Simply listing solutions with no matching or judgement stays mid-band.

Key Formulae — Cash flow

The formulae you need to memorise for cash flow on the Cambridge IGCSE paper, with every variable defined in plain English and a note on when to use it.

Net cash flow
$\text{Net cash flow} = \text{Total cash inflows} - \text{Total cash outflows}$
$Inflows$
cash receipts in the period (sales, loans, asset sales)
$Outflows$
cash payments in the period (wages, rent, materials, tax)
When to use
For each period (usually each month) of a cash-flow forecast; positive = surplus, negative = deficit.
Example
20,000 - 24,000 = -4,000
Closing balance
$\text{Closing balance} = \text{Opening balance} + \text{Net cash flow}$
$Opening balance$
cash held at the start of the period
$Net cash flow$
inflows minus outflows for the period
When to use
To find the cash held at the end of each period in a forecast; a negative closing balance means overdrawn.
Example
5,000 + (-4,000) = 1,000
Opening balance (carry forward)
$\text{Opening balance} = \text{Previous period's closing balance}$
$Previous closing balance$
the closing balance calculated for the prior period
When to use
To link months in a forecast — each opening balance equals the previous closing balance. Forgetting this is the most common Paper 2 error.
Example
Feb opening = Jan closing = 1,000
Working capital
$\text{Working capital} = \text{Current assets} - \text{Current liabilities}$
$Current assets$
cash, debtors and stock (convert to cash within a year)
$Current liabilities$
creditors, overdraft and short-term debt due within a year
When to use
To assess a firm's liquidity — the day-to-day money available to meet short-term debts.
Example
25,000 - 21,000 = 4,000

Key Definitions and Keywords — Cash flow

Definitions to memorise and the exact keywords mark schemes credit for cash flow answers — sharpened from recent examiner reports for the 2026 Cambridge IGCSE sitting.

Cash flow
Examiner keyword
The movement of cash into (inflows) and out of (outflows) a business over a period of time.
Related: Cash inflow, Cash outflow, Net cash flow
Cash inflow (receipts)
Cash received by a business, such as cash sales, payments from credit customers, loans and the sale of assets.
Example
A shop receiving $18,000 from customers in a month.
Cash outflow (payments)
Cash paid out by a business, such as wages, rent, raw materials, loan repayments and tax.
Example
Paying $22,000 in wages, rent and supplies in a month.
Net cash flow
Examiner keyword
Total cash inflows minus total cash outflows for a period; positive is a surplus, negative is a deficit.
Example
20,000 − 24,000 = −4,000 (a deficit).
Opening balance
Examiner keyword
The amount of cash a business holds at the start of a period; it equals the previous period's closing balance.
Closing balance
Examiner keyword
The cash a business holds at the end of a period; opening balance plus net cash flow. It carries forward as the next period's opening balance.
Cash-flow forecast
Examiner keyword
A financial document predicting the expected cash inflows, outflows and balances of a business over future periods.
Related: Net cash flow, Closing balance
Liquidity
Examiner keyword
The ability of a business to convert its assets into cash to pay its short-term debts as they fall due.
Insolvency
When a business cannot pay its short-term debts as they fall due; a common cause of business failure, even for profitable firms.
Working capital
Examiner keyword
The finance available for the day-to-day running of a business; current assets minus current liabilities.
Overtrading
When a business expands too quickly, taking on more orders than its working capital can support, causing a cash shortage.
Example
A firm winning big orders it must pay for before customers pay it.
Debt factoring
Selling unpaid customer invoices to a factoring company, which advances most of their value immediately in return for a fee.
Related: Debtors, Overtrading
Sale and leaseback
Selling a fixed asset to raise cash and then leasing it back so the business can continue to use it.
Overdraft
An arrangement allowing a business to withdraw more cash than it holds in its account, up to an agreed limit, with interest charged only on the amount used.
Trade credit
An agreement to buy goods or services from suppliers and pay for them later (e.g. within 30–60 days), delaying a cash outflow.

Common Mistakes and Misconceptions — Cash flow

The traps other students keep falling into on cash flow questions — taken from recent Cambridge IGCSE examiner reports and mark schemes — and how to avoid them.

✕Treating cash flow and profit as the same thing.
IB Diploma Programme Business Management Guide (first assessment 2024)
Why it happens
Both involve money, so students assume a profitable business automatically has cash and cannot fail.
How to avoid it
Remember profit is revenue − costs over a period, while cash flow is actual money in and out day to day. State explicitly that a profitable firm can still be illiquid and go insolvent.
✕Forgetting that the closing balance carries forward as the next month's opening balance.
IB Diploma Programme Business Management Guide (first assessment 2024)
Why it happens
Students calculate each month in isolation, or reset the opening balance to the original starting figure every month.
How to avoid it
Always set each opening balance equal to the previous month's closing balance. Draw an arrow linking closing → next opening as you work down the forecast.
✕Recommending a generic 'get a loan' instead of a solution matched to the specific problem.
IB Diploma Programme Business Management Guide (first assessment 2024)
Why it happens
A loan feels like an all-purpose fix, so students reach for it without diagnosing the actual cause or duration of the shortage.
How to avoid it
Diagnose the cause first (slow debtors? overstocking? a short-term gap?), then match the solution — factoring/tighter credit for slow debtors, overdraft/extended credit for a short gap, reducing stock for overstocking.
✕Mishandling negative figures — dropping the minus sign or mis-adding a deficit.
IB Diploma Programme Business Management Guide (first assessment 2024)
Why it happens
Forecast negatives are shown in brackets, and adding a negative net cash flow to a balance confuses students under time pressure.
How to avoid it
Treat brackets as a minus. Closing = opening + net cash flow, so a −4,000 net cash flow REDUCES the balance: 1,000 + (−4,000) = −3,000.
✕Confusing depreciation or credit sales as cash movements in a forecast.
IB Diploma Programme Business Management Guide (first assessment 2024)
Why it happens
These items affect profit, so students wrongly enter them as cash inflows or outflows.
How to avoid it
Only enter actual cash movements. Depreciation is a non-cash expense (never in a forecast); a credit sale enters the forecast only when the customer's cash is received, not when the sale is made.
✕In evaluation questions, listing solutions without weighing trade-offs or reaching a judgement.
IB Diploma Programme Business Management Guide (first assessment 2024)
Why it happens
Students describe several solutions to show knowledge but stop short of the AO3 skills of comparison and conclusion.
How to avoid it
For ~10-mark questions, weigh cost, speed, risk and side-effects, compare against an alternative, and give a conditional conclusion ('the best solution is X, provided Y').

Cash flow — the money moving in and out that keeps a business alive, and why it is not the same as profit

($)

January

February

March

Cash inflows (receipts)

20,000

18,000

30,000

Cash outflows (payments)

24,000

22,000

25,000

Net cash flow

(4,000)

5,000

Opening balance

5,000

1,000

(3,000)

Closing balance

1,000

(3,000)

2,000

The examined skill is recommending a specific solution matched to the specific problem — not a generic 'get a loan'. The main solutions:

Debt factoring — sell the business's unpaid invoices (debtors) to a factoring company, which pays ~80–90% of their value immediately. Best when the problem is slow-paying customers — it converts future receipts into cash now. Cost: the factor keeps a fee, so the business receives less than the full invoice value.
Sale and leaseback — sell a fixed asset (e.g. premises or vehicles) to raise a lump of cash, then lease it back and keep using it. Best for a one-off need to raise cash while retaining use of the asset. Downside: loses ownership and pays rent long-term.
Arranging an overdraft — an agreed facility to withdraw more than the account holds, up to a limit. Best for a short-term, temporary gap (like February in the forecast). Flexible — interest only on the amount used — but high interest and repayable on demand.
Negotiating extended trade credit — persuade suppliers to allow longer to pay (e.g. 30 → 60 days). Delays cash outflows to align with inflows. Risk: may lose early-payment discounts or strain supplier goodwill.
Tightening customer credit — reduce credit periods, credit-check customers, offer discounts for early payment. Speeds up cash inflows where over-generous credit is the cause. Risk: customers may switch to competitors offering easier terms.
Reducing stock levels — sell off or hold less inventory (e.g. just-in-time) to release the cash tied up. Best where overstocking is the cause. Risk: stock-outs and lost sales if demand jumps.
Short-term borrowing / loan — a last resort for a genuine long-term shortfall; increases interest costs and is slow to arrange, so it is rarely the best match for a temporary gap.

Cash flow

Detailed Study Notes

At a glance

What you’ll learn

Cash flow is not profit

The cash-flow forecast

Visualising the running balance

Causes of cash-flow problems

Solutions — matched to the problem

Working capital management

Quick recap

Memorise this

How it’s examined

Take this whole topic with you

1Calculating net cash flow for a month

2Finding the closing balance

3Completing a missing forecast line

4Building a full three-month forecast

5Interpreting the forecast — when and why cash runs short

6Calculating and interpreting working capital

7Testing a solution — the effect of an overdraft/extended credit

8Overtrading and debt factoring — a numeric check

9Choosing between two solutions

Net cash flow

Closing balance

Opening balance (carry forward)

Working capital

Cash flow

Cash inflow (receipts)

Cash outflow (payments)

Net cash flow

Opening balance

Closing balance

Cash-flow forecast

Liquidity

Insolvency

Working capital

Overtrading

Debt factoring

Sale and leaseback

Overdraft

Trade credit

✕Treating cash flow and profit as the same thing.

✕Forgetting that the closing balance carries forward as the next month's opening balance.

✕Recommending a generic 'get a loan' instead of a solution matched to the specific problem.

✕Mishandling negative figures — dropping the minus sign or mis-adding a deficit.

✕Confusing depreciation or credit sales as cash movements in a forecast.

✕In evaluation questions, listing solutions without weighing trade-offs or reaching a judgement.

Cash flow

Detailed Study Notes

At a glance

What you’ll learn

Cash flow is not profit

The cash-flow forecast

Visualising the running balance

Causes of cash-flow problems

Solutions — matched to the problem

Working capital management

Quick recap

Memorise this

How it’s examined

Take this whole topic with you

1Calculating net cash flow for a month

2Finding the closing balance

3Completing a missing forecast line

4Building a full three-month forecast

5Interpreting the forecast — when and why cash runs short

6Calculating and interpreting working capital

7Testing a solution — the effect of an overdraft/extended credit

8Overtrading and debt factoring — a numeric check

9Choosing between two solutions