Managing Cash Flow

Presented by Kate Barr, Nonprofits Assistance Fund

Session objectives

• Strategies for managing cash flow• The importance of proactive cash flow

management• Cash flow projections• Understanding working capital• Analyzing working capital needs• Learn from your peers

Part I

Cash Flow Projections

The importance of monitoring cash flow

• Cash flow is the fuel that sustains organizations and programs

• Cash flow shortfalls are disruptive• Cash flow shortfalls are costly

Monitoring cash flow

• Recognize the difference between negative cash flow and deficits

• Essential principles of managing cash flow:• Project and anticipate• Prepare options and strategies• Respond and adjust to changes

Projecting cash flow

• When to prepare cash flow projections

• Cash flow management philosophy• Base line cash balances• Use of credit lines• Use of restricted grant funds• Projecting uncertain income

Projecting cash flow

• Start with reliable budget information• Understand contract and grant terms

and experience• Understand operating cycles –

payroll, contracts• Include cash required for capital

purchases and debt service

Preparing projections

• Level of detail by line item• Time periods for projections• Use of projections – management,

board, outside users• Provide training for users of the

projections• Frequency and level of updates

Projecting cash receipts

• Grant income – committed & uncertain

• Restricted and special project funds• Receivables collection• Contract receivables• Individual fundraising• Pass-through funds

Projecting cash disbursements

• Reflect the anticipated timing of payments – not always divided by 12

• Payroll and benefits payment schedules

• Seasonal activities• Contracts and agreements with lump

sum payments• Debt service and capital purchases

Using cash flow projections

• What is a cash flow problem?• Anticipate cash flow shortfalls• Advance planning = more options• Clarify roles and responsibilities for

addressing projected shortfalls

Strategies for cash shortfalls

• Access operating cash reserves or available credit line• Have a plan for repayment

• Speed up cash receipts• Slow down cash disbursements

Part II

Defining and Analyzing Working Capital

Defining working capital• Working capital is always the first use of

cash• Businesses and nonprofits fight a three-

front war over the use of their cash:•Fixed assets•Debt service •Working capital

• Working capital is the first use of cash because a business or nonprofit cannot operate without inventory or service providers

Defining working capital

• Seasonal working capital• Temporary financing needs tied to the

business cycle or specific contracts• Financing rests during off season

• Permanent working capital• Longer-term investment to finance

steady growth over a period of time• Depends on proven pattern of sales or

revenue growth

Defining permanent working capital (PWC)

• Permanent investment of cash into operating assets and liabilities required to support revenues• Accounts receivable• Inventory• Accounts payable• Accruals

PWC formula

Accounts Receivable

+ Inventory

- Accounts Payable

- Accruals

= Permanent Working Capital

Measuring PWC

• Amount of PWC is determined by three factors:• Operating cycle(s)• Revenue levels• Rate and/or timing of revenue growth

PWC and the operating cycle

• Length of time, measured in days, that cash remains in operations before turning back into cash • Known as the cash-to-cash cycle• Determined by:

• Industry norms• Management capacity• Economic and market conditions• Policy considerations

Theoretical operating cycle

Receivable terms

+ Inventory cycle

- Supplier terms

- Payroll cycle

= Theoretical Operating Cycle

Actual operating cycle

Days receivable

+ Days inventory

- Days payable

- Days accrual

= Actual Operating Cycle

Variations in operating cycles

Community Health Center

Nonprofit organization

Days accounts receivable

Days grants receivable

- Days payable Days payable

- Days accrual Days accrual

= Operating Cycle Operating Cycle

Types of business operating cycles

LongHealth Center

ShortChildcare

NegativeRestaurant

Days receivable 120 45 0

+ Days inventory 20 0 3

- Days payable 30 21 30

- Days accrual 14 14 7

= Operating cycle 96 25 (34)

Comparing PWC needs: Revenue of $1 million

Health Center

Childcare

Restaurant

A/R $325,000

$123,000

$ 0

+ Inventory

5,000

0 6,000

- A/P 25,000

18,000

58,000

- Accruals 30,000

30,000

27,000

= PWC Needs

$275,000

$ 75,000 $(79,000)

Rule 1 of PWC analysis

• The longer the operating cycle, the more difficult it is to grow.• While the health center must invest 96

days, or $ 275,000 to support revenue, the childcare center invests only 25 days of cash, or $75,000.

• The restaurant do not invest any cash in operations—they use other people’s money.

Rule 2 of PWC analysis

• Financing one day of Accounts Receivable takes more cash than one day of inventory.• Receivables include the full value of all

costs and require more cash to support than other assets.

PWC and revenue level• Businesses and nonprofits with positive

operating cycles need more PWC for every increase in revenue• If the Health Center’s revenue doubled to $2

million, and the operating cycle stayed the same, PWC needs would increase to $550,000.

• Impact of revenue growth can be moderated by improved control of the operating cycle—as long as it improves for the right reasons (i.e., faster collections not slower payments).

PWC and rate of growth

• Businesses and nonprofits experiencing rapid growth syndrome face most serious problems financing PWC (if have a positive operating cycle)• Need for PWC grows faster than a

company or nonprofit can convert profits or surplus into cash.

• Sometimes gap can be filled only by equity or grants to lower the financial risk inherent in rapid growth.

Planning Working Capital Needs

• A step beyond managing cash flow• Plan the operations and policies for all

working capital components• Analyze the costs and opportunities of

different working capital scenarios

Step 1: Calculate existing PWC on the balance sheet.

Accounts receivable

+ Inventory

- Accounts payable

- Accruals

= PWC

All nonprofits except startups have an existing investment of PWC quantified on their balance sheet. New PWC is the difference between existing and projected PWC needs.

Step 2: Determine key assumptions for PWC projections.

• Use most recent trends.• Determine six assumptions.

• Rate of revenue growth• Direct Costs/Revenues• Days receivable• Days inventory• Days payable• Days accrual

Example :Change Receivables Cycle

Current

Longer

Shorter

Days receivable

120 180 100

+ Days inventory 20 20 20

- Days payable 30 60 30

- Days accrual 14 14 14

= Operating cycle

96 126 76

Example :Change Receivables Cycle

Current cycle

Longer Shorter

A/R $325,000

$487,000

$271,000

+ Inventory

5,000

5,000

5,000

- A/P 25,000

50,000

25,000

- Accruals 30,000

30,000

30,000

= PWC Needs

$275,000

$ 412,000

$221,000

Step 3: Project growth by using reverse operating cycle

equations

Days rec/360 X projected revenue

= Accts. Receivable

Days inv/360 X projected COGS

= Inventory

Days pay/360

X projected COGS

= Accts. Payable

Days acc/360 X projected COGS

= Accruals

New PWC

Step 4: Subtract existing PWC from projected PWC needs.

$New PWC Needs

- Existing PWC Investment

= $PWC to be funded or financed

Managing working capital

• Understand the operating cycle• Identify the controllable factors• Manage all factors in the cycle• Calculate the costs of working capital• Strategically invest in shortening the

operating cycle• Communicate with management and board

leaders