IB Business Management SL 2026 — Finance and Accounts

Videos on this page: Final Accounts — P&L and Balance Sheet · Ratio Analysis

---

Sources of Finance

Every business needs money to start up, grow, and keep operating. Finance is the fuel that allows a business to acquire resources, invest in new capacity, and weather periods of low cash flow. The central choice facing managers is: where should that money come from? The answer depends on how much is needed, how quickly, at what cost, and whether the business is willing to give up ownership or control in exchange for funds.

Sources of finance are classified along two dimensions: internal vs external and short-term vs long-term.

Internal Sources

Internal sources come from within the business itself. They do not involve borrowing or selling ownership stakes, so they carry no interest cost and do not dilute shareholder control. However, they are limited by what the business has already accumulated.

• Retained profit — The portion of after-tax profit kept in the business rather than paid as a dividend. This is the most important internal source for established, profitable businesses. It is “free” in the sense that no interest is paid, but it represents money that shareholders could otherwise have received.
• Sale of assets — Selling assets that are no longer needed (e.g., unused machinery, surplus property) generates a one-time cash inflow. This is only available where the business holds non-essential assets, and the assets may take time to sell.
• Working capital reduction — Tightening the management of current assets and current liabilities (e.g., collecting debtors faster, reducing inventory levels, or delaying payments to creditors) releases cash from the operating cycle without requiring external borrowing.

External Sources — Short-term

External short-term finance is typically used to cover temporary cash shortfalls or fund current operations.

• Bank overdraft — The business is permitted to withdraw more from its bank account than the balance allows, up to an agreed limit. It is flexible — interest is only charged on the amount overdrawn — but overdrafts are repayable on demand and carry relatively high interest rates.
• Trade credit — Suppliers allow the business to purchase goods or services now and pay later (typically 30–90 days). This is effectively an interest-free short-term loan if used within the agreed terms. It delays cash outflows without cost.
• Debt factoring — A factor (specialist finance company) purchases the business’s outstanding debtor invoices at a discount (e.g., paying 85 cents in the dollar immediately). The business receives cash quickly but loses a percentage of the invoice value as the factor’s fee.

External Sources — Long-term

Long-term finance funds major investments: new buildings, machinery, acquisitions, or sustained expansion.

• Share issue — Selling new shares to investors raises permanent capital. For a private limited company this means inviting new shareholders; for a public limited company it means a rights issue or new flotation. The business does not repay share capital, but shareholders expect dividends and a share of control.
• Debentures — Long-term bonds (loans) issued by the business to investors at a fixed rate of interest for a set period. Unlike bank loans, debentures can be traded on markets. The business must pay interest regardless of profitability.
• Bank loan — A fixed sum borrowed from a bank for a specified period at an agreed interest rate (fixed or variable). It is a straightforward, widely accessible form of long-term external finance.
• Leasing — Rather than buying an asset outright, a business can lease it — paying regular rental payments over the asset’s useful life. Operating leases leave asset ownership with the lessor; finance leases give the lessee most of the risks and rewards of ownership. Leasing preserves cash and avoids obsolescence risk.
• Microfinance — Small loans made to entrepreneurs in developing economies who lack access to traditional banking. Microfinance institutions (such as Grameen Bank) target low-income individuals and small businesses. Loan amounts are typically small; repayment rates are often high.

Comparison of Sources

Criterion	Internal	External
Cost	No interest; but represents forgone dividends	Interest charges or dilution of ownership
Availability	Limited by past profitability and asset base	Wider range, subject to creditworthiness
Speed	Generally quicker (no approval process)	Can be slow (loan applications, share issues)
Control	No dilution of ownership	Share issues dilute ownership; loans may include covenants

Time horizon	Short-term examples	Long-term examples
Typical duration	Under 1 year	1+ years, often 5–25 years
Examples	Overdraft, trade credit, debt factoring	Bank loan, share issue, debentures, leasing
Common use	Cover cash flow gaps, seasonal demand	Capital investment, expansion, acquisition

---

Costs and Revenues

Understanding how costs and revenues behave as output changes is foundational to all financial analysis in IB Business Management. Before calculating profit or performing break-even analysis, you must be able to classify costs correctly and calculate key financial figures.

Cost Classification

• Fixed costs (FC) — Costs that do not change with the level of output in the short run. They must be paid even if output is zero. Examples: rent, insurance, management salaries, depreciation, interest on loans.
• Variable costs (VC) — Costs that change directly and proportionally with the level of output. If output doubles, variable costs double. Examples: raw materials, direct labour (if paid per unit), packaging, electricity used in production.
• Semi-variable costs — Costs that contain both a fixed element and a variable element. A sales team’s pay, for instance, might consist of a fixed salary plus a commission per unit sold. Mobile phone contracts (fixed monthly charge plus per-minute charges) are another example.

Revenue

Revenue (also called sales revenue or turnover) is the total income earned from selling goods or services before any costs are deducted. It is calculated as:

$Revenue = Price \times Quantity$

Revenue is not the same as profit. A business may have high revenue but still make a loss if its costs exceed its income.

Profit and Contribution

Profit is the surplus remaining after all costs are deducted from revenue:

$Profit = Revenue - Total\ Costs$

Contribution is a particularly important concept for break-even analysis and decision-making. The contribution per unit is the amount each unit sold contributes toward covering fixed costs — and then to profit once fixed costs are fully covered:

$Contribution\ per\ unit = Selling\ price\ per\ unit - Variable\ cost\ per\ unit$

---

Break-even Analysis

Break-even analysis identifies the output level at which a business neither makes a profit nor a loss — total revenue exactly equals total costs. It is a powerful planning tool that helps managers understand the minimum sales volume needed to avoid a loss and the safety margin available before a loss occurs.

Break-even Output

The break-even point (BEP) is calculated using:

$BEP = \frac{Fixed\ Costs}{Contribution\ per\ unit}$

At break-even output, total revenue equals total costs:

$Total\ Revenue = Total\ Costs$ $Price \times BEP = FC + (VC\ per\ unit \times BEP)$

Margin of Safety

The margin of safety is the difference between the actual (or planned) level of output and the break-even output. It shows how much output could fall before the business starts making a loss:

$Margin\ of\ Safety = Actual\ output - Break\text{-}even\ output$

A positive margin of safety means the business is operating above break-even and can absorb a fall in demand without moving into loss.

The Break-even Chart

A break-even chart plots output on the horizontal axis (x-axis) and costs/revenue (in currency) on the vertical axis (y-axis). Three lines are drawn:

1. Fixed cost line — a horizontal line starting at the y-axis at the level of total fixed costs. It does not slope because fixed costs do not change with output.
2. Total cost line — starts at the same y-intercept as the fixed cost line (because total costs at zero output equal fixed costs) and slopes upward. The gradient equals the variable cost per unit.
3. Revenue line — starts at the origin (zero revenue at zero output) and slopes upward. The gradient equals the selling price per unit.

The break-even point is where the total cost line and the revenue line intersect. To the left of this point, total costs exceed revenue — the business is making a loss. To the right, revenue exceeds total costs — the business is profitable.

Limitations of Break-even Analysis

Break-even analysis is a useful but simplified model. Key limitations include:

• It assumes all output is sold — in reality, unsold inventory accumulates and revenue does not equal output times price.
• It assumes costs and prices remain constant — variable costs may change with bulk purchasing; selling prices may change with promotions or discounts.
• It treats variable costs as perfectly linear — in practice, costs per unit may fall at higher volumes (economies of scale) or rise (bottlenecks).
• It is a static model — it shows one break-even point at a moment in time and does not capture changes in the business environment.
• It is most reliable for single-product businesses; multi-product businesses require more complex analysis.

---

Financial Statements (Final Accounts)

Final accounts are formal financial statements prepared at the end of an accounting period to show what a business has earned and what it owns or owes. The two key statements for IB SL are the Income Statement (Profit and Loss Account) and the Balance Sheet (Statement of Financial Position).

The Income Statement

The income statement shows a business’s financial performance over a period of time (typically one year). It matches revenues earned against costs incurred to arrive at profit or loss.

Structure of the Income Statement:

Line	Description
Revenue (Turnover)	Total income from sales of goods/services
Less: Cost of Goods Sold (COGS)	Direct costs of producing the goods sold (opening inventory + purchases - closing inventory)
= Gross Profit	Revenue minus COGS — profit from core trading before operating expenses
Less: Operating Expenses	Indirect costs: rent, salaries, marketing, depreciation, utilities
= Profit Before Tax (Operating Profit)	Gross profit minus operating expenses
Less: Tax	Corporate tax on profit
= Net Profit (Profit After Tax)	The “bottom line” — available for dividends or retained in the business

Simplified Income Statement Example:

Item	$000
Revenue	500
Less: Cost of Goods Sold	(200)
Gross Profit	300
Less: Operating Expenses	(180)
Profit Before Tax	120
Less: Tax (20%)	(24)
Net Profit	96

The Balance Sheet

The balance sheet shows a business’s financial position at a single point in time. It is a snapshot of what the business owns (assets) and what it owes (liabilities), and the residual claim of owners (equity).

Structure of the Balance Sheet:

Section	Examples
Non-current assets (fixed assets)	Property, machinery, vehicles, intangibles (patents, goodwill)
Current assets	Inventory (stock), trade debtors, cash and bank balances
Current liabilities	Trade creditors, overdraft, tax payable (due within 1 year)
Non-current liabilities	Long-term bank loans, debentures (due after 1 year)
Equity (shareholders’ funds)	Share capital + retained profit (reserves)

Simplified Balance Sheet Example:

Item	$000	$000
Non-current Assets
Property and Equipment		400
Current Assets
Inventory	60
Trade Debtors	80
Cash	30
Total Current Assets		170
Total Assets		570
Equity
Share Capital	200
Retained Profit	130
Total Equity		330
Non-current Liabilities
Long-term Loan		150
Current Liabilities
Trade Creditors	70
Tax Payable	20
Total Current Liabilities		90
Total Equity and Liabilities		570

---

Watch: Final Accounts — P&L and Balance Sheet

lewwinski · 18 min · Constructing profit & loss statements, balance sheets, and depreciation — IB unit 3.4

Profitability and Liquidity Ratios

Ratio analysis uses figures from the income statement and balance sheet to assess a business’s profitability (how efficiently it generates profit) and liquidity (its ability to meet short-term obligations). Ratios are most meaningful when compared to previous years, industry benchmarks, or competitor data — a ratio in isolation tells you little.

Profitability Ratios

Gross Profit Margin (GPM) measures the percentage of revenue retained after direct production costs:

$GPM = \frac{Gross\ Profit}{Revenue} \times 100$

Net Profit Margin (NPM) measures the percentage of revenue retained after all operating costs:

$NPM = \frac{Net\ Profit}{Revenue} \times 100$

Return on Capital Employed (ROCE) measures how efficiently the business uses its total long-term finance to generate profit — the most important overall profitability measure:

$ROCE = \frac{PBIT}{Capital\ Employed} \times 100$

where PBIT = Profit Before Interest and Tax, and $Capital\ Employed = Total\ Equity + Non\text{-}current\ Liabilities$

Liquidity Ratios

Current Ratio measures the ability to pay short-term debts using all current assets:

$Current\ Ratio = \frac{Current\ Assets}{Current\ Liabilities}$

The ideal range is 1.5–2:1. A ratio below 1 indicates the business cannot cover its short-term debts. A very high ratio may indicate poor use of assets (excess cash or inventory).

Acid Test Ratio (Quick Ratio) is a more stringent test of liquidity — it excludes inventory because inventory is the least liquid current asset:

$Acid\ Test\ Ratio = \frac{Current\ Assets - Inventory}{Current\ Liabilities}$

The ideal is approximately 1:1. Below 1 suggests liquidity problems even before slow-moving stock is considered.

---

Watch: Ratio Analysis

tutor2u · 7 min · GPM, NPM, ROCE, current ratio, and acid test — IB Business unit 3.5 (note: video also covers A-Level efficiency ratios not required for IB SL)

Cash Flow

Cash flow refers to the movement of money into and out of a business over time. Understanding the distinction between cash and profit — and managing cash flow proactively — is essential for business survival.

Cash vs. Profit

A business can be profitable but cash-poor. Profit is an accounting concept that matches revenues with costs over a period, regardless of when cash actually changes hands. Cash flow is about the timing of actual receipts and payments.

A business may show a profit on its income statement but still run out of cash if:

• It sells goods on credit (revenue is recorded before cash is received)
• It has purchased large amounts of inventory (cash paid out but not yet converted to revenue)
• It has made a major capital investment (cash leaves the business immediately; the cost is spread over years through depreciation)

Cash Flow Forecast

A cash flow forecast is a forward-looking table showing expected cash inflows and outflows for each period (usually monthly), and the resulting cash balance. It allows managers to identify in advance when the business may run short of cash and take action before a crisis occurs.

Causes of Cash Flow Problems

• Overtrading — growing too fast without sufficient working capital to fund the increased activity
• Poor debtor management — customers paying late or not at all, leaving cash tied up in unpaid invoices
• Seasonal demand — businesses in seasonal industries face months of low or no inflows while fixed costs continue
• Unexpected costs — machinery breakdown, emergency repairs, or sudden cost increases
• Excessive inventory — buying too much stock ties up cash and creates storage costs

Solutions to Cash Flow Problems

Problem	Solution
Short-term cash shortfall	Bank overdraft — flexible, immediate, interest only on amount used
Cash tied up in assets	Sale of assets — one-time release of cash; may sacrifice future productive capacity
Slow debtor collection	Improve debtor management: offer early payment discounts, tighten credit terms, use debt factoring
Outflows arriving too early	Delay payments to creditors — negotiate extended payment terms with suppliers
Structural cash shortfall	Arrange a bank loan — more formal, planned source of medium-term finance

---

Investment Appraisal

When a business is considering a major capital investment — a new machine, a new building, an acquisition — it must assess whether the investment is financially worthwhile. Investment appraisal provides quantitative methods for evaluating the financial returns from a proposed investment and comparing alternative investment options.

All three IB SL methods require an initial estimate of: (1) the initial investment (outflow), and (2) the expected net cash inflows generated each year over the investment’s life.

Payback Period

The payback period is the length of time it takes for the cumulative net cash inflows from an investment to equal the initial outlay. It answers the question: “How quickly do we get our money back?”

$Payback\ Period = \frac{Initial\ Investment}{Annual\ Net\ Cash\ Inflow}$

This formula applies only when annual cash inflows are constant. When inflows vary by year, payback is found by accumulating inflows year by year until the initial outlay is recovered.

Advantages: Simple to calculate and understand; favours projects with quick returns, reducing risk exposure.

Disadvantages: Ignores the time value of money; ignores all cash flows after the payback point; does not measure overall profitability.

Average Rate of Return (ARR)

The ARR expresses the average annual profit from an investment as a percentage of the initial outlay, allowing comparison with alternative uses of money (e.g., leaving funds in a bank account):

$ARR = \frac{Average\ annual\ profit}{Initial\ investment} \times 100$

where average annual profit = (Total net cash inflows - Initial investment) / number of years.

Advantages: Considers all cash flows over the entire life of the investment; produces a percentage comparable to interest rates.

Disadvantages: Ignores the time value of money; uses averages, which may mask uneven cash flows.

Net Present Value (NPV)

NPV accounts for the time value of money — the principle that $1 received today is worth more than $1 received in the future, because money available now can be invested to earn a return. NPV discounts future cash flows back to their present value using a discount factor reflecting the cost of capital (or required rate of return).

$NPV = \sum_{t=1}^{n} \frac{CF_t}{(1+r)^t} - Initial\ Investment$

In practice, IB students use a discount table that provides the factor by which to multiply each year’s cash flow. If NPV is positive, the investment earns more than the cost of capital and is financially worthwhile. If negative, it destroys value.

Comparison of Investment Appraisal Methods

	Payback Period	ARR	NPV
What it measures	Speed of recovery of initial investment	Average annual return as % of initial investment	Net value created after discounting for time value of money
Accounts for time value of money?	No	No	Yes
Considers all cash flows?	No (ignores post-payback)	Yes	Yes
Output	Time (years/months)	Percentage (%)	Monetary value ($)
Best for	Risk-averse businesses; projects where liquidity matters	Quick comparison against interest rates	Financially sophisticated decisions; large, long-term projects
Limitation	Ignores total profitability	Ignores timing of cash flows	Requires a reliable discount rate; more complex

---

Practice Questions

The following questions cover all subsections of Unit 3. Attempt each question before revealing the model answer.

Question 1 — Sources of Finance: Justify a source for a small business (concept)

Question: A sole trader bakery has been operating for three years and has accumulated $15,000 in retained profits. It wants to purchase a second-hand commercial oven costing $12,000 to expand production. Justify the most appropriate source of finance.

Model Answer: The most appropriate source is retained profit. The bakery has sufficient accumulated profit ($15,000) to cover the full cost of the oven ($12,000). Using retained profit avoids interest charges (unlike a bank loan) and avoids diluting ownership (unlike a share issue, which is in any case unavailable to a sole trader). Since the investment is relatively modest and the business is profitable, there is no need to take on external debt. A bank loan would be appropriate if the business lacked sufficient retained profit or needed to preserve cash for working capital purposes.

Question 2 — Break-even Analysis: Calculate BEP and margin of safety (calculation)

Question: A business produces sports water bottles. Selling price: $15 per unit. Variable cost: $6 per unit. Monthly fixed costs: $4,500. Current monthly output: 600 units. Calculate: (a) the break-even output, (b) the margin of safety, and (c) the monthly profit at current output.

Model Answer:

(a) Contribution per unit = $15 - $6 = $9

$BEP = \frac{4500}{9} = 500 \text{ units}$

(b) Margin of safety = 600 - 500 = 100 units

(c) Total revenue = $15 x 600 = $9,000. Total variable costs = $6 x 600 = $3,600. Total costs = $3,600 + $4,500 = $8,100.

$Profit = \$9,000 - \$8,100 = \$900$

Alternatively: Total contribution = $9 x 600 = $5,400. Profit = $5,400 - $4,500 = $900.

Question 3 — Ratio Analysis: Calculate and interpret ratios (calculation + interpretation)

Question: A business reports: Revenue $800,000; Gross profit $320,000; Net profit $80,000; Current assets $150,000; Inventory $50,000; Current liabilities $100,000; Non-current liabilities $200,000; Total equity $350,000. Calculate and interpret the gross profit margin, current ratio, and acid test ratio.

Model Answer:

Gross Profit Margin: (320,000 / 800,000) x 100 = 40%. This means 40 cents of every dollar of revenue is retained after direct production costs. Whether 40% is good depends on the industry — supermarkets operate on much lower margins (5–10%); software companies may have margins above 70%.

Current Ratio: 150,000 / 100,000 = 1.5:1. This is at the lower bound of the ideal 1.5–2:1 range. The business can just cover its short-term debts using current assets. While acceptable, there is limited buffer — any unexpected outflow could create liquidity pressure.

Acid Test Ratio: (150,000 - 50,000) / 100,000 = 100,000 / 100,000 = 1:1. This exactly meets the 1:1 benchmark. Without relying on inventory sales, the business can exactly cover its current liabilities. This is adequate but leaves no margin for error.

Question 4 — Cash Flow: Identify problems and recommend solutions (concept)

Question: A clothing retailer operates on 60-day credit terms with customers (debtors). Suppliers demand payment within 15 days (creditors). The business has experienced growing sales but its bank balance has fallen sharply. Identify two causes of the cash flow problem and recommend two solutions.

Model Answer:

Cause 1 — Debtor collection lag: The retailer allows customers 60 days to pay, but must pay suppliers within 15 days. Cash leaves the business 45 days before it is received from customers. As sales grow, this gap creates an increasingly large cash shortfall despite the business being profitable.

Cause 2 — Overtrading: Growing sales require increasing purchases of inventory. The business is paying for stock before it has received payment from customers, which ties up cash.

Solution 1 — Reduce debtor days: Introduce early payment discounts (e.g., 2% discount for payment within 10 days) to incentivise faster payment. Alternatively, tighten credit terms from 60 to 30 days for new customers.

Solution 2 — Negotiate extended creditor terms: Approach suppliers to extend payment terms from 15 to 45 days. This closes the gap between cash outflows and inflows, reducing the working capital requirement.

Question 5 — Investment Appraisal: Compare payback and NPV for a decision (concept + evaluation)

Question: A business is choosing between two machines. Machine A has a payback period of 2 years and an NPV of -$5,000 at a 12% discount rate. Machine B has a payback period of 4 years and an NPV of +$18,000 at a 12% discount rate. Recommend which machine the business should purchase. Justify your answer.

Model Answer: The business should purchase Machine B, despite its longer payback period, because its NPV is positive (+$18,000), meaning the investment creates $18,000 of value in today’s money terms after accounting for the time value of money and the 12% cost of capital. Machine A’s negative NPV (-$5,000) means it destroys value at the required rate of return — it earns less than the cost of the capital employed and should not proceed on financial grounds.

Payback period favours Machine A (2 years vs 4 years), and if the business is highly risk-averse or has serious liquidity concerns, rapid capital recovery may matter. However, as a decision rule, NPV is theoretically superior because it accounts for the time value of money and considers all cash flows over the investment’s entire life. A business that chooses Machine A solely on the basis of payback would be selecting a value-destroying investment. Machine B is the financially sound choice.

Question 6 — Income Statement: Identify the correct placement of items (concept)

Question: State whether each of the following appears in the income statement or the balance sheet, and in which section: (a) retained profit; (b) trade debtors; (c) cost of goods sold; (d) long-term bank loan; (e) gross profit.

Model Answer:

(a) Retained profit — Balance sheet, equity (shareholders’ funds) section. It is the accumulated past profits kept in the business.

(b) Trade debtors — Balance sheet, current assets section. Debtors are customers who owe the business money — a short-term asset expected to convert to cash within the year.

(c) Cost of goods sold — Income statement, deducted from revenue to calculate gross profit.

(d) Long-term bank loan — Balance sheet, non-current liabilities section. A liability due after more than one year.

(e) Gross profit — Income statement, calculated as revenue minus cost of goods sold. It is a subtotal within the income statement, not a balance sheet item.