chapter 8: cash flow1copyright 1999 prentice hall publishing company managing cash flow

Chapter 8: Cash Flow 1Copyright 1999 Prentice Hall Publishing Company

ManagingCash FlowManagingCash Flow


Why Manage Cash?Why Manage Cash?

The most common reason small The most common reason small businesses fail is running out of cash.businesses fail is running out of cash.

Cash is the most important, yet least Cash is the most important, yet least productive, asset a business owns. productive, asset a business owns.

Survey of business owners: “Biggest Survey of business owners: “Biggest financial obstacle” was “uneven cash financial obstacle” was “uneven cash flow.” flow.”


Cash Cash Profits Profits Remember: Cash and profits are Remember: Cash and profits are notnot

the same!the same! A company can earn a profit and still A company can earn a profit and still

go out of business because it runs out go out of business because it runs out of cash.of cash.


Cash Cash Profits Profits Remember: Cash and profits are Remember: Cash and profits are notnot

the same!the same! A company can earn a profit and still A company can earn a profit and still

go out of business because it runs out go out of business because it runs out of cash.of cash.

Young, fast-growing companies are Young, fast-growing companies are especially vulnerable. especially vulnerable.

The Cash Flow Cycle

OrderOrderGoodsGoods

DayDay 11

ReceiveReceiveGoodsGoods

1515

PayPayInvoiceInvoice

4040

1414 2525

218218

178178

SellSellGoods*Goods*

DeliverDeliverGoodsGoods

221221

33

CustomerCustomerPays**Pays**

SendSendInvoiceInvoice

230230

99

280280

5050

Cash Flow Cycle = 240 daysCash Flow Cycle = 240 days

* Based on Average Inventory Turnover:* Based on Average Inventory Turnover:

365 days 365 days = 178 days = 178 days 2.05 times/year2.05 times/year

** Based on Average Collection Period:** Based on Average Collection Period:

365 days 365 days = 50 days = 50 days 7.31 times/year7.31 times/year


Entrepreneurs’ Five Cash Entrepreneurs’ Five Cash Management RolesManagement Roles

1. Cash Finder - first and foremost responsibility.1. Cash Finder - first and foremost responsibility.

2. Cash Planner - ensures efficient use of cash.2. Cash Planner - ensures efficient use of cash.

3. Cash Distributor - forecasts cash disbursements 3. Cash Distributor - forecasts cash disbursements and pays bills on time.and pays bills on time.

4. Cash Collector - makes sure customers pay their 4. Cash Collector - makes sure customers pay their bills on time.bills on time.

5. Cash conserver - sees that company gets 5. Cash conserver - sees that company gets maximum value for every dollar spent. maximum value for every dollar spent.


The Cash BudgetThe Cash Budget is a "cash map," showing the amount and the is a "cash map," showing the amount and the

timing of a firm's cash receipts and cash timing of a firm's cash receipts and cash disbursements over time.disbursements over time.

predicts the amount of cash a company will need predicts the amount of cash a company will need to operate smoothly.to operate smoothly.

is a helpful tool for visualizing the firm's cash is a helpful tool for visualizing the firm's cash receipts and cash disbursements and the receipts and cash disbursements and the resulting cash balance.resulting cash balance.


Preparing a Cash BudgetPreparing a Cash Budget Determine a Minimum Cash Determine a Minimum Cash

BalanceBalance Forecast SalesForecast Sales Forecast Cash ReceiptsForecast Cash Receipts Forecast Cash DisbursementsForecast Cash Disbursements Determine End-of-Month Determine End-of-Month

Cash BalanceCash Balance


Remember Goldilocks, the Three Bears, Remember Goldilocks, the Three Bears, and the porridge: and the porridge:

Not too much...Not too much... Not too little...Not too little... but a cash balance that's just right ... for but a cash balance that's just right ... for

you!you!

Determine a Minimum Determine a Minimum Cash BalanceCash Balance


The The heartheart of the cash budget. of the cash budget. Sales are ultimately transformed into Sales are ultimately transformed into

cash receipts and cash disbursements.cash receipts and cash disbursements. Prepare three sales forecasts:Prepare three sales forecasts:

Most LikelyMost Likely PessimisticPessimistic OptimisticOptimistic

Forecast SalesForecast Sales


Record all cash receipts when Record all cash receipts when actually actually received received (i.e. the cash method of (i.e. the cash method of accounting).accounting).

Determine the collection pattern for Determine the collection pattern for credit sales; then add cash sales.credit sales; then add cash sales.

Forecast Cash ReceiptsForecast Cash Receipts

Collecting Delinquent Accounts

93.80%

85.20%

73.60%

57.80%

42.80%

23.60%

13.60%

0.0% 20.0% 40.0% 60.0% 80.0% 100.0%

24

12

9

6

3

2

1

Probability of Collection


Start with those disbursements that are fixed Start with those disbursements that are fixed amounts due on certain dates.amounts due on certain dates.

Review the business checkbook to ensure Review the business checkbook to ensure accurate estimates.accurate estimates.

Add a cushion to the estimate to account for Add a cushion to the estimate to account for "Murphy's Law.""Murphy's Law."

Don’t know where to begin? Try making a Don’t know where to begin? Try making a dailydaily list of the items that generate cash and list of the items that generate cash and those that consume it.those that consume it.

Forecast Cash DisbursementsForecast Cash Disbursements


Take Beginning Cash Balance...Take Beginning Cash Balance... Add Cash Receipts...Add Cash Receipts... Subtract Cash DisbursementsSubtract Cash Disbursements Result is Cash Surplus or Cash Shortage Result is Cash Surplus or Cash Shortage

(Repay or Borrow?)(Repay or Borrow?)

Determine End-of-Month Determine End-of-Month BalanceBalance


The "Big Three" The "Big Three" of Cash Managementof Cash Management

Accounts Receivable.Accounts Receivable. Accounts Payable.Accounts Payable. Inventory.Inventory.


About 90% of industrial and wholesale sales About 90% of industrial and wholesale sales are on credit, and 40 percent of retail sales are are on credit, and 40 percent of retail sales are on account.on account.

Recent survey of small companies across a Recent survey of small companies across a variety of industries found that 77% extend variety of industries found that 77% extend credit to their customers.credit to their customers.

Remember: “A sale is not a sale until you Remember: “A sale is not a sale until you collect the money.”collect the money.”

The goal with accounts receivable is to collect The goal with accounts receivable is to collect your company’s money as fast as you can.your company’s money as fast as you can.

Accounts ReceivableAccounts Receivable


Establish a firm credit-granting policy.Establish a firm credit-granting policy. Screen credit customers carefully.Screen credit customers carefully. When an account becomes overdue, take action When an account becomes overdue, take action

immediatelyimmediately.. Add finance charges to overdue accounts (check the law Add finance charges to overdue accounts (check the law

first!).first!). Develop a system of collecting accounts.Develop a system of collecting accounts. Send invoices promptly.Send invoices promptly.

Accounts ReceivableAccounts ReceivableBeating the Cash CrisisBeating the Cash Crisis


Stretch out payment times as long as Stretch out payment times as long as possible possible without damaging your credit without damaging your credit ratingrating..

Verify Verify allall invoices before paying them. invoices before paying them. Take advantage of cash discounts.Take advantage of cash discounts. Negotiate the best possible terms with Negotiate the best possible terms with

your suppliers.your suppliers.

Accounts PayableAccounts PayableBeating the Cash CrisisBeating the Cash Crisis


Be honest with creditors; avoid the "the Be honest with creditors; avoid the "the check is in the mail" syndrome.check is in the mail" syndrome.

Schedule controllable cash disbursements Schedule controllable cash disbursements to come due at different times.to come due at different times.

Use credit cards wisely.Use credit cards wisely.

Accounts PayableAccounts PayableBeating the Cash CrisisBeating the Cash Crisis


Monitor it closely; it can drain a Monitor it closely; it can drain a company's cash.company's cash.

Avoid inventory "overbuying." It ties Avoid inventory "overbuying." It ties up valuable cash at a zero rate of return.up valuable cash at a zero rate of return.

Arrange for inventory deliveries at the Arrange for inventory deliveries at the latest possible date.latest possible date.

Negotiate quantity discounts with Negotiate quantity discounts with suppliers when possible.suppliers when possible.

InventoryInventoryBeating the Cash CrisisBeating the Cash Crisis


Avoiding the Cash CrunchAvoiding the Cash Crunch

Consider bartering, exchanging goods and Consider bartering, exchanging goods and services for other goods and services, to services for other goods and services, to conserve cash.conserve cash.

Trim overhead costs. For example:Trim overhead costs. For example: Lease rather than buy.Lease rather than buy. Avoid nonessential cash outlays.Avoid nonessential cash outlays. Negotiate fixed loan payments to coincide Negotiate fixed loan payments to coincide

with your company’s cash flow.with your company’s cash flow.


Avoiding the Cash CrunchAvoiding the Cash Crunch

Trim overhead costs. For example:Trim overhead costs. For example: Buy used equipmentBuy used equipment Develop an internal security system Develop an internal security system Devise a method for fighting check fraud.Devise a method for fighting check fraud.

Change your shipping terms to “F.O.B. Seller.”Change your shipping terms to “F.O.B. Seller.” Switch to zero-based budgeting.Switch to zero-based budgeting. Keep your business plan current.Keep your business plan current. Invest surplus cash.Invest surplus cash.


Though my bottom line is black, Though my bottom line is black, I am flat upon my back;I am flat upon my back;My cash flows out, My cash flows out, and the customers pay slow.and the customers pay slow.The growth of my receivables is almost unbelievable;The growth of my receivables is almost unbelievable;The result is certain - unremitting woe!The result is certain - unremitting woe!And I hear the banker utter that ominous low mutter,And I hear the banker utter that ominous low mutter,“Watch cash flow.”“Watch cash flow.”

- Herbert S. Bailey- Herbert S. Bailey

chapter 8: cash flow1copyright 1999 prentice hall publishing company managing cash flow

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