Cash is King

The cash flow report is probably one of the most important reports to use in running a company, especially a smaller one. There have been profitable companies that have closed due to their inability to manage cash. The P&L statement does not evaluate your spending for inventory and capital equipment, or your management of receivables and payables.

For most small businesses it is important to know the historical cash flow (all accounting systems have cash flow reports), but it is even more important to be able to forecast and manage future cash flow. It is a rare company that does not have limited cash balances at some time during its business cycle. And the ability to predict to some degree the cash “ins and outs” is the key to a well run company.

Many companies have established lines of credit which they can use when cash is short, but there is an interest cost. If a company is going in and out of their line all the time, it is often an indication that they may not be managing their cash---which could lead to the question “How well is the company run?”

A real life example.

I was hired by a client to help them understand why they were increasing their borrowings from their bank. Their profits had continued to increase for the past 18 months, yet they were borrowing more. They had not made any significant capital expenditures, which they knew used cash. They generally reviewed their company results by looking only at the monthly P & L. They did not review the balance sheet or even consider some of the major components of it. In my conversations, I asked about inventory levels. They thought it had gone up a little bit as more space was being used, but had not given it too much thought as they were making money. Well, their inventory value had increased 25%. When asked about how well their customers were paying, they said that some customers were not paying as timely as in the past. Upon analysis, the total amount due from customers was up 20%. And they always paid their vendors on time in order to get their discount.

Profits are considered to be the primary source of cash, but there are many other ways that cash can be generated. Inventory can be sold down. Inventory purchases should be reviewed to determine if some adjustment could be made in order quantity. Consider changing customer payment terms to speed up the inflow of accounts receivable. The cost of giving a discount for prompt payment should be compared with the cost of borrowing to cover your cash needs. Follow up with your customers when they are late. You can slow down vendor payments, or speed them up to take advantage of your vendors’ discounts. Leasing equipment, versus buying it, will allow delayed cash outlays. Borrowing additional funds can generate cash, but you must consider the interest cost.

Forecasting cash flow is not as difficult as it may seem. If you concentrate on the major items your forecast should be reasonable.
• To predict cash inflow from profits, first determine your projected sales for the next few months. Most companies have a reasonable idea of future sales from contracts, orders, etc. Based on the historical percent of profits to total sales, estimate the profit by month.
• Historical information on the number of days that accounts receivable are outstanding can be used to estimate the receivables at this time or in the future, based on your sales forecast. To do that, divide the accounts receivable balance by the average daily sales amount. If you have determined that some customers are going to slow their payments, include that in your projection.
• Sales again will give some idea of the amount of inventory that will be consumed, and you probably can use the sales level to predict purchase orders and receipt dates for incoming products for inventory. Or just estimate your major inventory purchases.
• Once this is done, you can review the amount of cash that you should have for payment of accounts payable and capital purchases. Never forget payroll and taxes.

More companies fail in their first few years due to the inability to manage cash than for any other reason. Often the company had sufficient cash resources, but managed them poorly. Cash is King!

Bill Boyer is the President of CEO Focus of the Tidewater and an AdviCoach® with BAI. He can be reached at bboyer@ceofocus.com or 757-233-2577.


Cash is King - To learn more about this author, visit Bill Boyer's Website.

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