RN October07Money Matters ●
ment grants, cash from the sale of fixed assets, deposit interest and so on. When all cash inflows have been detailed on a monthly basis, a total cash inflow for each month can be set out. This amount, plus reserves, gives you a cumulative cash flow for the period and will be the opening balance for the next period.
Outflows Cash outflows will include expenditure on such items as wages and salaries, administration costs, general and financial expenses, capital expenditure and so on. No distinction is made between capital expenditure, such as new equipment purchased, or revenue expenditure, such as wages etc. Purchases of stock will be a sizeable outflow for the retailer. But remember it is the date of payment for the stock that is important, not the date it was bought. So taking account of the credit terms for purchases, you can then reach a total cash outflow for each period. This figure should then be compared with the total cash inflow to give a net cash flow figure for each period. As a business grows, coming to grips with financial forecasting becomes more complicated. If the business’ activities are not carefully monitored, predicting the financial future becomes no more than guesswork. Knowing payment schedules in advance should influence all aspects of the business, including pricing, late payment policies and sales effort. To do this, you need to carefully manage the flow of cash.
Process Cash flow management as a process has not changed much over the past few decades. All businesses need to get to grips with their finances to understand what is coming in and what is going out. Business may be booming but overtrading can spell ruin if cash flow is not adequate. Overtrading occurs when a business is growing its sales levels without the appropriate working capital funding in place to match increased costs. To avoid situations like overtrading, you need to set up a cash flow forecast, outlining expected inward and
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outward flows of cash in a period before these flows actually take place. Regularly adjust the forecast to take account of changes in a business’ cash flow pattern that were not anticipated when completing the original forecast. This knowledge provides the business with a means of estimating the level of activity at which the business can operate. It provides information on how much cash is available during a particular month.
Caution Even the most accurate of cash flow forecasts may not allow for the vulnerability of the smaller company. The owner may feel that the business is in a sufficiently strong liquidity position to take on a special order later in the year, but unforeseen circumstances, such as rising costs, rising interest rates, unpaid bills, staff problems etc., may necessitate updating the cash flow forecast, or allowing for a cash cushion to cover such unforeseen events. A cash
“Should you find cash flowing out is greater than that coming in, then you must act. There are a number of things you can consider. You could streamline stock, staff or reduce fixed assets.”
flow forecast requires a constant awareness of danger and vigorous control. Should you find cash flowing out is greater than that coming in, then you must act. There are a number of things you can consider. You could streamline stock, staff or reduce fixed assets. Borrowing to grow is a risky option as it distorts the profit-to-sales ratio. A highly geared company, particularly a small company, has added vulnerability to increasing levels of interest rates. Even when the underlying business risk is relatively low, this financial risk can still sink a business. In the past, most companies owned their premises, machinery and equipment. These days, many large companies enter into sale and leaseback agreements on land, buildings and equipment. Leasing and renting items such as machinery, office equipment, motor vehicles or sub-contracting out particular processes like deliveries and collection can all lead to reduced cash outflows and must be considered.
Equity When looking at profits, take in the broader picture. Do not just look at profits relative to sales. Instead relate profits to equity. Equity consists of the original investment, together with profits that have been ploughed back in. A business with a high return on equity and good growth prospects is in a very strong position. Planning and information are the main keys to successful cash flow management. Planning ahead, through cash flow projections and forecasts enables management to make the fullest use of its most valuable asset, namely cash. It allows likely cycles of inflows and outflows to be smoothed over and longer-term cash needs to be anticipated and catered for. Setting up a chart of cash moving in and out of the business each month takes time but is worth it. Putting the time and effort into forecasting your cash needs well in advance, and ideally allowing for that rainy day cushion, will pay off in the long run.