Cash flow management is the most difficult task of finance managers. Though in big companies it is managed more carefully and easily by specialists; in small and medium sized companies this is a permanent worry.

There is a general tendency to confuse profits with cash and many times I have come across businessmen asking where the cash in their business is when they have made profits. They also think that the net profit shown in the profit and loss account would be reflected in their cash balance. Though profits indicate the cash earned in the business, it is not usually retained in cash alone. It could have been used to increase inventory, receivables or could have been used for financing capital assets, repaying loans, creditors etc.,. While profits are the excess of income over expenditure for a particular period, cash is what is available physically at a particular moment. 

How does one overcome the cash flow worries and manage business happily?

First it must be clear that all activities in business involve cash or cash equivalents and decisions are to be taken bearing this in mind.  Though there are many ways for cash outflows, the only sources of cash inflow are capital, loans and realisation of sale proceeds.

Capital cannot be a daily source or raised as and when required. It is the same with Loans except when borrowing is from short-term sources like private financiers and temporary arrangements.  Hence the only regular source of cash inflow is from sales and receivables and this is where businessmen have to concentrate the most.

As most business is done on credit, attention and care to this aspect in management is of utmost importance. Receivables management calls for careful choice of customer.  It is most common in small and medium enterprises to let the customers dictate terms and most of the times; the failure in business is the blocking of money in their accounts.  After all, one should realize that the cash cycle is not complete unless sale proceeds are realized as and when required.  In receivables management, credit rating of customers is a must; however important and big they could be to the organization. Too much dependence on hopes and promises is dangerous.  Typically, receivables should not go beyond 90 days under any circumstances. Also, facilities from banks is not easy on receivables beyond 90 days and it is not worth waiting to collect the money from a customer who has no ability to pay within this time.

Most of the times, entrepreneurs take the burden of paying to their suppliers on time and resort to short term borrowings and accommodation from bankers neglecting the real cause for blockage of their funds. Not taking firm decisions on receivables hampers the cash inflows adding to the miseries.

Cash normally gets blocked in finished good inventories where production planning is improper.  Also, work-in-progress blocks quite an amount of cash putting pressure on the cash generation and its management.  

Where all commitments have to be met on schedule, cash inflow can be organized only through proper care and planning. How many firms prepare cash budgets? Though most firms prepare monthly profit and loss accounts to know their profitability, this statement does little to the overall efficiency.   

Preparing forecast cash flow statement would help improve cash management. In most cases it is a non-starter due to the uncertainties in projecting the inflows. In spite of this, one must attempt to prepare a cash budget based on assumed inflow from debtors and prepare a plan to bridge the deficit through loans or temporary arrangements. By this exercise, one is warned in advance of the things to come and also prepares the manager to take corrective action well in advance. Many a time, if there is going to be a delay in payment of a commitment, the creditors can be informed in advance enhancing the image of the enterprise.

Method of Preparing a cash budget

One must develop one’s own method to prepare a cash budget. In most cases where cash budget is made, the projected receipts are first depicted and then the payments. However, in almost all practical situations, one plans to meet the commitments out of receipts and hence depicting the outflow first would be more appropriate. From this the minimum required inflow could be judged and the receivables / other sources could be chased to manage the situation.

Action Points for effective cash management Make conservative estimates of cash receipts. Prioritise creditors payments Bridge the deficit through least cost alternatives Compare the actual cash flows to budgets, analyse the variance and adopt the lessons learnt in future. Never borrow to repay a loan or for paying a creditor unless the terms are beneficial Borrow on long term and never divert short term funds to long term use like asset purchase, marketing expenditure etc., Closely monitor the operating cycle. Do not carry excess cash in business, put it to best use. Remain liquid.

 

Periodicity of cash budgets:

Though profitability statements are prepared for convenience on monthly/annual basis, cash management being a day-to-day affair, it would be wise to prepare a weekly cash budget irrespective of the size.  Weekly budgets enhance the focus better and give less room for complacency leading to greater efficiency.  Short-term budgets help firms improve forecasting skills, adaptability and maneuverability in cash management

In summary, a firm must be viewed as a cash machine.  It has to make strategic decisions in order to generate more cash than it spends.  If a firm keeps spending more cash than it generates, it will eventually end in trouble.  Thus, the ability of managers to make decisions that generate cash over time is essential for a firm’s long-term survival.  Making profits will help, but only if this profit can be quickly converted into cash.  The firm’s suppliers, its bankers and tax authorities require payments in cash, not profits.  Most of the time, though strategic decisions, (which are long term by nature), are carefully taken, good operating decisions are overlooked due to pressure and circumstances, which lets the cash machine break down.  Hence, continuous and closely monitored operating decisions are required for efficient day-to-day management of the firm’s operating cycle, which can over time; help generate more cash than is consumed.

(The Author Murali is from DoMore Financials & Consulting (P) Ltd. which provides financial counselling and a helping hand for all financial needs. For feedback send mail to This e-mail address is being protected from spam bots, you need JavaScript enabled to view it )

Issue BG17 Aug02

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