IB Business Management HL 3.7 Cash Flow Questions

Evaluate cash-flow forecasts, liquidity pressures and recovery strategies to justify financial decisions in IB Business Management HL cases.

Exam points

Define and identify the key concepts and tools in 3.7 Cash flow.
Apply 3.7 Cash flow to business calculations, case evidence or management decisions where relevant.
Analyse and evaluate 3.7 Cash flow using case context, stakeholder impacts and business trade-offs.

Covered syllabus points

3.7.1—Profit and cash flow 3.7.2—Working capital 3.7.3—Liquidity position 3.7.4—Cash flow forecasts 3.7.5—Investment, profit, and cash flow 3.7.6—Cash flow problem strategies

[Maximum number: 2]

Rox and Inclusive Music (IM)
Rox was a music band managed by Michel Mbappe. The band enjoyed considerable commercial success thanks to Michel's autocratic leadership style. He personally made all decisions. Rox had given generously to local schools and other non-profit organizations. The band received many awards for their acts of corporate social responsibility. Their last CD "Action Not Words" had brought them considerable fame.
In June 2010, Michel was asked to help finance the start-up of a new non-profit music school called "Inclusive Music" (IM). IM's aim was to support young musicians from low income families. At first, Michel was very enthusiastic and prepared a business plan. Unfortunately, he realized that Rox could not afford to finance IM fully. External sources of finance other than contributions from Rox would be needed for IM to grow. Until then IM would only have a limited budget for marketing and market research.
In June 2011, IM opened with the mission statement "Action not words". To support its mission, it offered free lessons and allowed students to borrow musical instruments. Michel asked a popular former singer, Louis Marsaud, to be the school's director. Louis adopted a laissez-faire leadership style, hoping it would allow creativity among students. Initial student attendance was lower than expected and quickly worsened. Within three months, many instruments had gone missing and many students were no longer attending music lessons.
IM's finances were deteriorating, and Louis could not attract external sources of finance. Michel took action and organized a concert by Rox to promote IM. He also examined IM's accounts and discovered a significant liquidity problem. Without consulting anyone, he dismissed Louis. In the music media, Michel received much criticism for dismissing Louis. Journalists argued that the two main problems were, IM's vague mission statement and poor marketing. However, Michel aimed to ensure that IM became sustainable in the long term.

Identify two possible causes of a liquidity problem.

[Maximum number: 4]

Creative Toys (CT)

Creative Toys (CT) manufactures toys and markets them business-to-customers (B2C) online only. The business operates in a leased industrial site and relies on word-of-mouth promotion only. To make customers believe that CTs toys are better than its competitors, CT sets prices slightly higher than the competition. Production and sales are mostly between 1 October and 24 December. Most of the employees work on temporary contracts during this busy period. For the remainder of the year, CT operates well below capacity utilization.
Table 1 contains selected data for CT, for 2014:

Table 1

In 2014, the management of CT considered a change of the marketing mix to include above the line promotion, lower prices, and an additional sales method called "toy parties". Toy parties would be hosted by newly recruited CT sales representatives and attended by parents and their children. At the parties parents could see the toys and children could play with them. Sales would be made at the parties by the new sales representatives, who would be paid on a commission-only basis.

Toy parties could be held throughout the year and make CTs total sales less seasonal. Based on market research, management has estimated that the parents' demand for toys is price elastic and is planning to set lower prices for all toys sold online and at toy parties. The management has prepared forecasted financial data for CT, for 2015, based upon the proposed change to the marketing mix, shown in Table 2 below.

Table 2

The Finance Manager will carry out a variance analysis in order to determine whether the proposed change to the marketing mix has been successful.

Using information from Table 2, prepare an annual cash-flow forecast for CT, for 2015.

Item	Amount
Cash sales revenue	€352000
Total receipts	€352000
Fixed costs	€180000
Raw materials	€128000
Sales commissions	€32000
Variable costs	€32000
Total payments	€372000
Net cash flow	(€20000)
Opening balance	€37000
Closing balance	€17000

[Maximum number: 10]

Cool Meals (CM)

Cool Meals (CM) produces frozen organic ready-made meals that are sold to food retailers throughout the country.
CM buys large quantities of organic ingredients from local farmers for its just-in-case (JIC) stock control management. It uses a cost-plus (mark-up) pricing strategy.
CM is known for its:
- good-quality organic frozen meals, which are perceived as good value for money
- flexibility with retailers in terms of quantity of meals supplied, credit given and efficient delivery at pre-arranged dates
- corporate social responsibility (CSR) based on a long-term commitment made to farmers to purchase large quantities of organic ingredients every four months and pay a fair price promptly
- CM has an excellent working relationship with farmers, who always prioritize CM's requests in terms of quantity and delivery.
Recently, an economic downturn and increased competition, especially from non-organic frozen meal suppliers, has decreased demand for frozen organic meals.
The finance manager of CM, Kayleigh, provided the following financial information.

Table 1: Selected financial information for CM

Kayleigh is worried about the cash flow of CM and suggested the company changes the stock control method from just-in-case (JIC) to just-in-time (JIT). She is also looking at other strategies to improve CM's financial position.

Using the financial information in Table 1, evaluate two strategies that CM could use to improve its financial position other than changing to a just-in-time (JIT) stock control method.

It is expected that candidates make constant reference to/use of the figures and other relevant information in the stimulus combined with theoretical understanding of the advantages and disadvantages of the possible strategies.

Some of the possible strategies:
Reduce cash outflow. CM is facing cash flow crisis as seen by its deteriorating acid test ratio of 0.6 . Without stock, which contributed to a high current assets ratio, C M cannot meet its long-term liabilities. It is evident that there is a big difference between debtors and creditors days. CM paid the farmers within five days in 2018, which is very quick and got significantly quicker - twice as fast but received money from the retailers after 70 days in 2018, a significant increase from 50 days. C M is too generous to retailers with the credit term. Despite the
fact that the relationship with retailers and the suppliers is CM's competitive advantage, it is financially dangerous given the decreasing and very low acid test.

Seek alternative suppliers with cheaper agriculture produce might be seen as an extreme solution, as CM's relationship with the farmers and the quality of the organic ingredients are key to its competitive advantage. It might take a long time to find different suppliers. Perhaps agreeing a longer credit term would be a better solution. Currently, CM pays after five days. One can assume that the farmers are likely to prefer a request for a longer pay period than a more drastic one.

Cut expenses. Gross profit margin is considerably higher than net profit margin for a manufacturing company and is getting worse over time. CM should look at some unnecessary expenses like marketing or administration. However, cutting salaries or staff might impact on the employees' motivation and cutting marketing might create some difficulties in competing with the new competitors. However, going out of business due to lack of cash can be judged as a more significant threat.

Do not accept better stock control due to JIT.
Tighter credit control. Cash payments only for the retailer will clearly reduce/eliminate debtor days. The acid test ratio is worrying and CM must take immediate actions to solve this short-term liquidity problem. However, the relationship with the retailers might deteriorate and they might start buying non-organic frozen food from the emerging competitors. It appears that CM's bargaining power with the retailer is weak and this option is unlikely to be successful. One, however, may argue that increasing the creditor days is unlikely to be met with much objection from its suppliers given the very low starting figures and long-established trust. CM might also be able to ask its debtors - the retailers - to pay sooner, even after two months, a demand which is likely to be seen as reasonable.

Changing pricing policy. CM can possibly reduce the price of its products. While CM may be more competitive and this strategy may work well given the economic downturn and the increased competition, CM may suffer losses or a reduction in profit. However, customers may perceive the frozen organic meals as even better value for money and increase demand. Moreover, perhaps CM can withstand a reduction in profit in the short term and we can see that C M is profitable. The liquidity issue ought to be sorted. CM should prioritize its cash flow problem first, then deal with a low acid test to generate cash to survive.

Enhance marketing to generate more sales in cash. CM might be able to reduce its increasing level of stock and reduce stock turnover in days, which has clearly deteriorated considerably from 20 to 40 days. However, any type of promotion may incur more expenses, especially in cash. The data indicates that the net profit margin is considerably lower than the gross profit margin, which indicates that CM does not control its expenses well.

Improved product portfolio. Perhaps CM should also consider non-organic meals or other types of products to enhance its portfolio and create more revenue streams. However, cannibalism can be created - CM may also have to compete more directly with the increasing number of providers of non-organic frozen meals. Market research has to be done so perhaps this option is not the most appropriate one in the short term.

Seeking alternative short term sources of finance. Accept relevant applicable suggestions like the use of overdraft and short-term loans, to deal with CM's short-term liquidity crisis. However, these options are more of first aid rather than solution to some ongoing problems and are likely to be more theoretical given the lack of information in the stimulus.

It is not expected that the candidates cover all of the above.
Accept any other relevant arguments for and against any relevant suggested strategy.

Accept any other relevant examination.
A conclusion with judgment is expected.
A balanced response covers at least one argument for and one argument against each of two different strategies.

Marks should be allocated according to the mark bands on page 3 with further guidance below.

For one relevant issue that is one-sided, award up to [3]. For more than one relevant issue that is one-sided, award up to a maximum of [4].

Award a maximum of [6] if the answer is of a standard that shows balanced analysis and understanding throughout the response with reference to the stimulus material but there is no judgment/conclusion.

Candidates cannot reach the [7-8] markband if they give judgment/conclusions that are not based on analysis/explanation already given in their answer.

It is expected that the candidate goes beyond just providing some relevant arguments for or against any suggested strategy and finish off with some conclusions and judgment.

Award a maximum of [4] marks if the answer, regardless of balance and judgment makes no reference to either the figures or headings in Table 1

Candidates, in order to reach to the top markband, should show clear evidence of substantiation/well supported.

For the top markband, candidates must make use of the financial information given in their discussion.

All question bank results loaded

Covered syllabus points

Question 1

Question 2

Question 3