It’s all about the BENJAMINS
By Dennis Graham
Financial Planning
Universal Advisor, 2003 Issue No. 2

Cash flow to a business is like oil to a machine — you need it to run properly, and you’re in big trouble if you run out of it. So why is it that businesses sometimes find themselves with net income but no cash?

Put simply, timing. Revenue may be earned in the current period, but a company’s terms or common industry practices may allow customers to pay on extended credit. Cash outlays for such items as furniture and equipment (capital expenditures) occur in a current period but are only gradually included as subtractions from income in the form of depreciation. Conversely, income statement items such as depreciation and amortization are not direct cash outlays, so they must be added back to net income to determine a company’s ability to generate cash.

So how do companies better manage cash flow and prevent cash crises? Easy — by engaging in cash forecasting, shortening the cash payment/collection cycle, investing idle funds effectively, and establishing appropriate internal controls. These practices can help keep a company running like a well-oiled machine.

Cash Forecasting
Cash forecasting models can range from a simple spreadsheet to sophisticated business planning software packages. But the first step in all cash forecasting is to analyze the recent months’ receipt and outflow patterns to estimate future receipts and disbursements. Don’t forget required periodic tax payments or capital expenditures when making assumptions about disbursements. When mapping out future cash activity, the need for borrowing and the opportunities for investing excess cash are obvious. Early identification of such needs and opportunities will result in time for evaluating and executing alternatives.

The Cash Cycle
The cash cycle is defined as the time it takes from the payment of items purchased for sale (or the time service is provided) to the time receipts are collected from the customer. Effectively managing this cycle can yield dramatic, positive results for an organization. Managing supplier and customer terms should be coordinated for consistent results. For example, let’s say a supplier offers you discount terms of “2, 10 net 30.” A 2 percent discount for paying in 10 days instead of 30 doesn’t sound like a lot, but it represents an annualized discount of 36.5 percent. Likewise, offering and enforcing customer incentives and terms to pay you promptly will affect your ability to take advantage of supplier discounts.

Effective Banking and Short-Term Investment
There are a number of bank products designed to assist with cash management and make the most of excess cash, but pay careful attention to the related service fees. It’s a good idea to periodically meet with your bank service representative to evaluate various cash management products and their potential costs and benefits.  One of the most common ways to make use of idle cash without excessive administrative burden is the sweep account, in which the bank monitors a client’s balance and “sweeps” any excess cash into an overnight investment or against the company’s line of credit borrowings. This option is typically available to businesses that meet bank-imposed average daily balance minimums and other requirements.

An option that works well for smaller businesses is a money market account, combined with a separate disbursement account funded by transfers that can be used for check writing.

Controlled disbursement accounts are a powerful cash management tool. These accounts allow a company to keep a small balance (or zero balance, in some cases) in their bank disbursement accounts until checks or other debits are presented for payment. Funding of disbursements may be handled manually or automatically by the bank. The company has use of its funds for investment up until the time items are presented for disbursement.

Appropriate Internal Controls
At times, a lack of cash may be a warning sign that cash is being misappropriated. A company can safeguard cash through the proper segregation of accounting and cash handling duties. Separate the receipt of cash from the recording of cash transactions, ensuring that the employee recording cash receipts is not the same individual who reconciles the bank account. Additionally, the timely completion of bank reconciliations and proper reconciliation procedures could alert management to unusual transactions or allow for the prompt correction of bank errors. Additionally, policies and procedures for setting up new customer and vendor accounts are an important component of sound control measures. Many employee frauds result from the ability to control cash, customer, and vendor accounts; your newest vendor may well turn out to be a soon-to-be-former employee.

Cash Is Still King!
Sufficient cash is one of the most important critical success factors of long-term business survival. Proper cash flow forecasting, shortening the cashcycle, wisely investing idle funds, and implementing internal controls over cash can avert cash crises and assure the continued success of your business.