chapter 9: cash flow 1 copyright 2005 prentice hall inc. a pearson education company managing cash...

Chapter 9: Cash FlowChapter 9: Cash Flow 11Copyright 2005 Prentice Hall Inc. A Pearson Education CompanyCopyright 2005 Prentice Hall Inc. A Pearson Education Company

ManagingCash FlowManagingCash Flow


Cash ManagementCash Management

Young, growing companies are “cash sponges.”Young, growing companies are “cash sponges.” A business can be earning a profit and be A business can be earning a profit and be

forced to close because it runs out of cash! forced to close because it runs out of cash! Cash management – forecasting, collecting, Cash management – forecasting, collecting,

disbursing, investing, and planning for the cash disbursing, investing, and planning for the cash a company needs to operate smoothly. a company needs to operate smoothly.

The Cash Flow CycleThe Cash Flow Cycle

OrderOrderGoodsGoods

Day 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


Five Cash Management Roles of Five Cash Management Roles of an Entrepreneuran Entrepreneur

Cash FinderCash FinderCash PlannerCash PlannerCash DistributorCash DistributorCash CollectorCash CollectorCash ConserverCash Conserver

Cash FlowCash Flow

Cash

Accounts Payable

Decrease in CashDecrease in Cash

Production/Cash Purchases

Inventory

Accounts Receivable

Cash Sales

Increase in CashIncrease in Cash

LeakageLeakage

LeakageLeakage


The Cash BudgetThe Cash Budget

A “cash map,” showing the amount and A “cash map,” showing the amount and the timing of a firm's cash receipts and the timing of a firm's cash receipts and cash disbursements over time.cash disbursements over time.

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

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


Preparing a Cash BudgetPreparing a Cash Budget

Determine a Minimum Determine a Minimum Cash BalanceCash Balance

Forecast SalesForecast SalesForecast Cash ReceiptsForecast Cash ReceiptsForecast Cash Forecast Cash

DisbursementsDisbursementsEstimate End-of-Month Estimate 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 LikelyPessimisticPessimisticOptimisticOptimistic

Forecast SalesForecast Sales


Sales Forecast for a Start-UpSales Forecast for a Start-Up

Example:Example:Number of cars in trading zoneNumber of cars in trading zone 84,000 84,000 x Percent of importsx Percent of imports x 24%x 24%= Number of imported cars in trading zone= Number of imported cars in trading zone 20,160 20,160Number of imports in trading zoneNumber of imports in trading zone 20,160 20,160 x Average expenditure on repairsx Average expenditure on repairs x $485x $485= Total import repair sales potential= Total import repair sales potential $9,777,600 $9,777,600Total import repair sales potentialTotal import repair sales potential $9,777,600 $9,777,600 x Estimated market sharex Estimated market share x 9.9%x 9.9%= Sales estimate= Sales estimate $967,982$967,982


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

13.60%

23.60%

42.80%

57.80%

73.60%

85.20%

93.80%

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 Disbursements…Subtract Cash Disbursements…Result is Cash Surplus or Cash Shortage Result is Cash Surplus or Cash Shortage

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

Estimate End-of-Month Estimate End-of-Month BalanceBalance


Benefits of Cash ManagementBenefits of Cash Management

Increase amount and speed of cash flowing in.Increase amount and speed of cash flowing in. Reduce the amount and speed of cash flowing Reduce the amount and speed of cash flowing

out.out. Develop a sound borrowing and repayment Develop a sound borrowing and repayment

program.program. Impress lenders and investors.Impress lenders and investors. Reduce borrowing costs by borrowing only Reduce borrowing costs by borrowing only

when necessary.when necessary.


Benefits of Cash ManagementBenefits of Cash Management(continued)(continued)

Take advantage of money-saving opportunities Take advantage of money-saving opportunities such as cash discounts.such as cash discounts.

Make the most efficient use of available cash.Make the most efficient use of available cash. Finance seasonal business needs.Finance seasonal business needs. Provide funds for expansion.Provide funds for expansion. Plan for investing surplus cash.Plan for investing surplus cash.


The "Big Three" ofThe "Big Three" of Cash Management Cash Management

Accounts ReceivableAccounts ReceivableAccounts PayableAccounts Payable InventoryInventory


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

Survey of small companies across a variety of Survey of small companies across a variety of industries found that 77% extend credit to industries found that 77% extend credit to their customers.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 cash as fast as you can.your company’s cash 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 Add finance charges to overdue accounts (check

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

Accounts ReceivableAccounts Receivable

Beating the Cash CrisisBeating the Cash Crisis


Accelerating Accounts ReceivableAccelerating Accounts Receivable

Ask customers to fax or e-mail orders.Ask customers to fax or e-mail orders.Send invoices when goods are shipped.Send invoices when goods are shipped.Highlight the due date on invoices.Highlight the due date on invoices.Restrict customers’ credit until past-due Restrict customers’ credit until past-due

bills are paid.bills are paid.Deposit checks and credit card receipts Deposit checks and credit card receipts

daily.daily.


Accelerating Accounts ReceivableAccelerating Accounts Receivable(continued)(continued)

Identify the top 20% of your customers Identify the top 20% of your customers and monitor them closely.and monitor them closely.

Ask customers for up-front payments.Ask customers for up-front payments.Watch for signs that a customer may be Watch for signs that a customer may be

about to declare bankruptcy.about to declare bankruptcy.Consider using a lockbox service.Consider using a lockbox service.Track the results of your company’s Track the results of your company’s

collection efforts.collection efforts.


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.

Accounts PayableAccounts PayableBeating the Cash CrisisBeating the Cash Crisis

The Cost of Foregoing a Cash DiscountThe Cost of Foregoing a Cash Discount$1,000 invoice$1,000 invoice 2/10, net 302/10, net 30

DayDay

AmountAmount

00 1010 3030

$1,000$1,000$980$980

20 days20 days

$20$20

R = R = IIP x TP x T

= $20$20$980 x 20/360$980 x 20/360

= = 36.7%36.7%


Negotiate the best possible terms with Negotiate the best possible terms with your suppliers.your suppliers.

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 up Avoid inventory “overbuying.” It ties up valuable cash at a zero rate of return.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: Periodically evaluate expensesPeriodically evaluate expenses Lease rather than buyLease rather than buy Avoid nonessential cash outlaysAvoid nonessential cash outlays Negotiate fixed loan payments to coincide with your Negotiate fixed loan payments to coincide with your

company’s cash flowcompany’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 Hire part-time employees and freelancersHire part-time employees and freelancers Devise a method for fighting check fraudDevise a method for fighting check fraud Change shipping termsChange shipping terms Switch to zero-based budgetingSwitch to zero-based budgeting

Be on the lookout for employee theftBe on the lookout for employee theft Keep your business plan currentKeep your business plan current Invest surplus cashInvest surplus cash

(continued)(continued)

chapter 9: cash flow 1 copyright 2005 prentice hall inc. a pearson education company managing cash...

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