Michael Goldman & Associates, L.L.C. - Consulting
& CPA Services
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Goldman's Critical Support - Summer 2001 Cash
Management As the economy dips down, and banks and investors get more
skittish, more and more businesses will feel a liquidity pinch. Companies
without strong cash management skills will be taken advantage of by companies
that are more adept at holding onto their money. Cash is the lifeblood of every
company, and in an environment starved for liquidity there is no truer saying
than “only the strong survive.” While often delegated to a mid-level employee who does not
have much clout within the organization, cash management is not for the
faint-hearted. Good cash management requires a strong personality able to keep a
steady course in rough seas, financial acumen, and the ability to forecast at
least the immediate future with a good degree of accuracy. The most critical aspect of cash management is
understanding the flows – the business cycle of the company, where cash is
generated from, and where it is going. Start with the company’s operating plan (assuming that it
realistically projects what management expects to happen in the coming months).
The plan should be built from the bottom up and detail revenue by major
customer, major location, or other appropriate delineator of the significant
sources of revenue. Once you identify the revenues, identify the expenditures
that must be made to support those revenues. The next element of the flow to identify is the timing of
each element in the cycle – how long it takes to collect revenues, how long
vendors can be stretched out, etc. 13-week critical
plan In critical situations, cash flow should be planned in
extensive detail in 13-week intervals. Specifically identify each major source
and use of cash, and forecast with as much accuracy as possible the exact timing
of when the cash will be received or disbursed. Two key actions must be done
with this plan – update it each week and compare forecast activity to actual
activity. This comparison will allow you to test your assumptions, hone your
technique, and make adjustments for unexpected items. Utilizing the plan in this
manner will allow management to be proactive and influence the timing of both
receipts and disbursements. The 13-week cash flow plan should be used interactively by
management to set targets and monitor progress in all aspects of working capital
management. Some of the key elements of this are: ·
For accounts receivables, establish management procedures to
improve: a.
Average collection periods and aging b.
Credit quality of the receivable portfolio, risk of slow-pay or no-pay
customers c.
Invoicing procedures to reduce slow payments due to paperwork issues and
bottlenecks or slowdowns in the billing process d.
Conversion of receivables to cash Generally,
good operating discipline will ensure good customer payment. ·
For inventory, establish management procedures to: a.
Better determine economic order quantities at different levels of
forecasted cash balances b.
Improve inventory turnover – evaluate safety stock levels, buying
procedures, etc. c.
Turn obsolete inventory into cash d.
Focus on cash instead of gross margin or other profitability measures ·
For accounts payable, establish management procedures to: a.
Allow the company to be less reactive to vendor threats (prioritize
vendors, find alternate vendors, etc.) b.
Consistently stretch out average payment terms c.
Obtain discounts or some other concession when faster payment is
demanded. Vendors will generally accept slower payment than
they would like as long as management is upfront and honest, has a credible plan
to restore the company to solvency, and treats each class of vendor fairly. Keep them informed Communication is critical for effective cash management –
managers need to know what their spending limits are, creditors need to know
when to expect payments if they are not going to be made on a timely basis, and
constant contact must be maintained with customers to ensure that their payments
are received on a timely basis. Cash flow Remember that GAAP accounting often bears little
relationship to cash flows. If a company imports a product from Asia, it may pay
for the goods on day one, have the goods shipped on day 90, receive the goods
and clear customs on day 120, store the goods until their customer orders them
on day 150, and get paid by the customer on day 240. According to GAAP
accounting, nothing happened (other than the acquisition of an asset called
“inventory”) until day 150, when the company recognized both sales and
profit. From a cash standpoint, the company spent cash on day one and did not
receive cash in return for that expenditure until day 240. The long and short
of it The most critical element of proper cash flow management is
keeping in mind that there is no long-term without a short-term. Too many
management teams are looking so far ahead at how much money they will make as a
result of the new machinery and equipment that they have purchased, the
tremendous bargains that they got by buying materials or supplies in huge
quantities, and the opportunity that could not be passed up, that they neglect
to plan how they can pay for them in the short term. Growth usually requires
cash expenditures to provide the new products or services before they can be
billed and paid for. It bears repeating – cash is the life-blood of every business, and there is no long-term if you bleed to death in the short-term. Pay close attention to your cash flows.
© Michael Goldman 2001 For more information, please go to www.michaelgoldman.com Editorial material in these newsletters is intended to be informative, and should not be construed as advice. For advice on any specific matter, please consult your financial or legal adviser.
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