Managing Cash Flow

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Valley of death- time that company experiences negative cash flow as they ramp up operations/ build customer base/ become self supporting

Cash Management- process of forecasting/ collecting/ disbursing/ investigating/ planning for cash company needs to operate

• Cash flow cycle- time lag between paying suppliers for merchandise/ materials and receiving customer payment

  • First step in managing cash more effectively/ the longer the cycle, more likely to experience cash crisis

Cash and Profits are not the same (survival depends on ability to generate positive cash flow) (cannot evaluate bus on profit)

• income statement does not tell the condition of company's cash flow/ only displays accounts receivable

• company's cash balance does not increase until it collects the payment (if ever does)

• Profit is the difference between company's total revenue/ total expenses- measures efficiency of business

• Cash Flow- method of tracking company liquidity/ ability to pay bills on time. Track cash flow in/out of business

• decreases in cash when business purchases (on credit or cash) goods for inventory or materials for production

• profitability does not guarantee liquidity/ can't pay with profit and must have cash flow

Cash Budget (Map)- amount/ timing of cash receipts/ cash disbursements on a daily/ weekly/ monthly basis

• Cash-------Decrease in cash: Accounts payable to Production/ cash purchases--------Inventory (leakage)--------- ---Increase in cash: Cash sales to Accounts receivable (Leakage))-------back to cash

• uneven flow creates periodic cash surpluses and shortages/ goal of cash management=available to suit needs

• Used to predict amount of cash a company will need to operate smoothly/ enlightens future problems

• owners need to prepare projected monthly cash budget for 1 year/ quarterly estimates (cover seasonal fluctuating)

• cash budget (accounting) cash receipts/ disbursements recorded in forecast/ cash trans expected to place

• cash budget is nothing more than forecast of firms inflows and outflows of cash

Step 1: Determining an adequate minimum cash balance

• firms cash balance = ¼ of current liabilities/ rec. a cash reserve for 6 months of operating expenses

• method of deciding minimum is based on past experiences

Step 2: Forecasting sales:

• 3 estimates (optimistic/ pessimistic/ most likely sales estimate) make separate cash budget

• creating accurate picture of firm's cash position/ sales trans into cash receipts/ distributions

• sales = source of cash flow/ sale of merchandise requires cash to replenish inventory

• cash budget is only as accurate as the sales forecast in which it was derived

• sales forecast based on past sales/ don't be overly optimistic in projections of cash flow

• economic swings, increased competition, demand fluctuations, seasonal variations affect sales pattern

Step 3: Forecasting Cash Receipts (sales constitute primary source)

• when company sells goods on credit/ cash budget must account for the delay of sale/ collection

• Electronic (auto clearing house) collections- bank service allows business to deduct automatically invoice amounts from customers accounts and deposit them into sellers account in 24 hours

• Remote deposit- bank service allows business to scan customers checks/ deposit them from anywhere

Step 4: Forecasting Cash Disbursements- cash on hand to pay bills when due

• entrepreneurs should know the burn rate in which they can spend each month

• when forecasting distributions for cash budget is to record them in the month they will be paid in

• expenses such as inventory/ materials/ wages/ rent/ utilities/ taxes/ loans/ ads/ fixed assets

Step 5: Estimate End of Month Cash Balance (must determine beginning balance first)

• includes cash on hand and in checkings/ savings- can anticipate cash shortages/ surpluses

• cash balance at end becomes beginning balance next month

• adds beginning balance/ subtracts disbursements to get balance before any borrowing

• positive amounts = surplus / negative = shortage unless there is collecting/ raising/ borrowing

• must watch for trends in balance/ seasonal fluctuations/ establish a weekly report

The big threes of cash management (three primary causes of cash flow problems)

• Cash conversion cycle- time required to convert inventory/ accounts payable into sales/ accounts receivable and back into cash. (days inventory outstanding/ days sales outstanding- days payable outstand)

• 1- Accounts Receivable: most challenging is collecting money that is due

  • establish collection policy by screening customers before granting credit/ references

  • establish written credit policy/ specify limit/ requires deposits/ discounts/ consequences

  • send invoices promptly so they are reminded/ sooner the better- hire collection attorney

  • Cycle Billing: comp. bills portion of credit customers each day/ smooth out uneven cash receipts

  • Security Agreement: business selling asset on credit gets a security interest in that asset (collateral) protecting its legal rights in case the buyer fails to pay

• 2- Accounts Payable: stretch out payables as long as possible without damaging credit rating

  • Never have bad relations with suppliers/ check all invoices/ extend credit limit

• 3- Inventory: offer wider variety of products to gain competitive edge/ needs tight inventory

  • largest investment for many businesses/ creates strain on cash flow/ wrong inventory

  • inventory is illiquid and can siphon off available cash/ need to turn quickly

  • low inventory loses sales/ high inventory runs out of cash quicker- money tied up here

  • Quantity discounts: gives businesses a break when order large quantities (Non/Cumulative)

  • Cash Discounts: offered to customers as an incentive to pay for merchanduse promptly

Avoiding the cash crunch

• Bartering- exchange of products/ services for other products/ services rather than cash

• Trimming overhead costs/ negotiate discounts/ conduct expense audits/ lease instead of buying

• Operating Lease-offered to customers as an incentive to pay for merchandise promptly/ obligation

• Capital Lease- end of lease. Company will offer a buying option for equipment (nominal sum)

• avoid nonessential outlays/ buy used equipment/ hire part time/ outsource/ use e-mail/ credit card small purchases

• negotiate loan payments/ establish internal security & control system/ battle system check fraud

• change shipping terms/ sell gift cards/ zero based budgeting/ look for theft/ build cushion/ invest surplus

• Money market account- interest bearing account allows depositors to write checks without tying up their money for a specific period of time

• Zero balance account- checking account that never has any funds in it. Company keeps money in an interest bearing master account tied to ZBA (withdraws cash from master account to cover expenses)

Sweep account- checking account that automatically sweeps all funds in a company checking account above a predetermined minimum into an interest bearing account