Cash is king

Integration is not only important in the delivery of AV solutions - it is also a key component of successful cash management. Nick Topazio, reporting specialist at the Chartered Institute of Management Accountants, explains how the integration of business cash drivers and cash flow reporting and forecasting models are critical to success.

There is a saying that ‘turnover is vanity whereas, profit is sanity’ indicating that any commercial organisation needs to make profits to survive in the long term. But sanity is not necessarily enough; cash is the lifeblood of a business and without sufficient flows of it the business will wither and die. And this is a sentiment that has never been more apt, as organisations and particularly small and medium sized entities (SMEs) continue to experience bank credit restriction.
So what can the SME do to best equip itself to ride out this economic storm and emerge from it with stronger controls and processes?

The business cash cycle
The SME needs to have a clear understanding of their business model and in particular the cash cycle. How long is there typically between placing an order for goods, receiving them, paying for them, selling them and receiving payment? Does this vary by supplier, by type of product or in any other material way? What is the general pattern of trade? Are there cyclical trends that influence the level of purchases and sales, and is there a big trade fair or other sales opportunity coming up that stock needs to be bought for?

Once the trading cash cycle has been understood then the other cash flows that affect a business need to be reviewed; for a SME these would typically include salaries, rent, tax payments, utility bills etc. Some of these are more regular in nature than others, and as such the timing can be easier to forecast. However, it is possible to negotiate fixed monthly payments for what would otherwise be deemed a variable cost, such as a utility bill. In this way you establish a greater degree of certainty over the cash outflows that need to be serviced by either trading inflows or bank credit. Yes, bank credit is more difficult to obtain in the current liquidity squeeze but a detailed cash forecast will help demonstrate to your financiers that you are managing cash efficiently and as such reduce the risk of default. There are also internal planning benefits - some cash outflows result from discretionary expenditure which can be deferred if the cash forecast indicates that you will breach your credit facilities if you make this payment

The cash forecast

Apr

May

Jun

Jul

Aug

Sep

Opening Bank Balance

500

150

0

-850

-1050

-400

Payment to suppliers

-750

-800

-1500

-500

-700

-500

Receipts from customers

800

800

800

1200

1500

2400

Salaries / Commissions

-100

-100

-100

-100

-100

-150

Rent

-250

-250

Utility bills

-50

-50

-50

-50

-50

-50

Capital Expenditure

-500

Closing Bank Balance

150

0

-850

-1050

-400

1300


A simplified cash forecast covering a period of the next six months

This forecast demonstrates a problem faced by many businesses having to pay for goods well in advance of receipts from their sale. In this case stocks are being built up maybe for a big sales event and have to be paid for in June although cash receipts from the event do not flow back into the organisation until later in the year. Faced with this forecast the SME obviously needs to consider their credit facilities. In this case an overdraft or other loan facility is needed to cover June, July and August. Obtaining such a facility may not be easy but rest assured it will be easier trying to negotiate the necessary credit in early April with a cash balance of 500 than waiting for the bank to call in June to say that your current account is overdrawn. By that time the item of capital may have been ordered, meaning that the outflow will be generated in July, making matters even worse.


Planning is more effective with accurate cash forecasts. For instance, assume the trip to the bank manager in April was successful and a short-term overdraft was agreed but that the limit was set at 1,000. The cash forecast shows that the capital expenditure needs to be deferred so that payment does not need to be made until at least August.

Learn from experience
A rolling cash forecast should be maintained that prompts regular reviews of future cash flows with necessary amendments based on experience and expectations. It is very important not to simply forecast; it is equally important to monitor actual cash flow against forecast. Is the assumption of the amount of time it takes to collect cash receipts from date of sale, and in the case of retail sales does this includes any delay in receiving cash for credit card sales? Have purchases of goods for resale and the payment for them been in line with expectations? If not, do future forecast assumptions need to be changed to reflect this new knowledge? Monitoring daily cash balances and analysing the source of movements in the bank account is an important element of cash management, especially for SMEs that rely on bank finance.
Sensitivity analysis is also important. Again this is all a part of being prepared. Ask yourself what would be the effect of a delay in receipts from customers, how likely is it, how much could be delayed and what can you do to mitigate the downside risk? Faced with such a scenario, the SME might decide that it would be best to delay the capital expenditure until the increased cash receipts actually start to flow later in the year. There may be a downside to delaying the capital purchase and the impact of this needs to be factored into the assessment. What this type of planning buys the SME is ‘time to prepare’ which can be the difference between survival and extinction.

Optimising the working capital cycle
Cash management is not just about having an accurate cash forecasting model. The manager of an SME needs to have a thorough grasp of the key cash drivers in the business, such as receivables, payables and inventory, so as to optimise the investment in working capital and maximise the cash generative potential of the entity.

Customers are key; from the moment a product is ordered by a customer to the point at which payment is made there are a number of important activities that can be carried out to try to reduce the working capital cycle by increasing the likelihood of timely payment. A well defined credit policy is the starting point. It needs to be written and communicated to all involved both internally and externally. It is important that the sales force understand the policy and especially the fact that ‘a sale is not a sale until it is paid for’. This is particularly key in respect to any sales commission schemes. Payment of commissions or bonuses in advance of cash realisation is a recipe for failure – and doesn’t just relate to SMEs.

Cash collection
Customers need to understand payment terms and the SME needs to be proactive in its cash collection processes. These start with accurate, efficient and prompt invoicing. Too often days or weeks pass before an invoice is issued because the manager of the SME is too busy chasing the next sale. It is very unusual for a credit customer to pay in advance of receiving an invoice and often payment cycles only start once an invoice has been received.

As well as being prompt, invoices need to be accurate and clearly state the agreed payment terms. Discounts for prompt payment and user friendly payment mechanisms such as electronic payment can be offered to accelerate cash inflows.

Depending on the size of the SME there should either be a designated person or a certain time set aside in the manager’s day to review credit allowed. It is important to be able to identify default accounts operating outside of credit terms as soon as possible so that corrective action can be taken. Many SMEs report that large organisations are late payers and the above actions will not necessarily avert this, however it all reduces the likelihood of late payment.

For those SMEs offering credit facilities a tried and tested metric that should be employed is Days Sales Outstanding. DSO expresses the current amount owed to an organisation in terms of equivalent days’ sales (if you are owed 3000 and your average days sales are 100 then DSO is 30). DSO, once measured, should be compared to average credit terms and the DSO trend should be monitored. Many software packages produce ‘Aged Debtor’ analyses from which the oldest debts can be identified. These reports should be reviewed on a regular basis and action taken to pursue debts outside of credit terms. Even friendly reminders of amounts due in the near future may help to speed payments.

Inventory Management
Many SMEs have to contend with large suppliers and often the balance of power is not with the SME when it comes to negotiating favourable payment terms. That is not to say that the SME should not try to do so, it just means that controls of cash outflows on purchases are likely to be more internally-focussed. There should be a strict policy of ‘no purchase order, no payment’ supported with an appropriate sign-off policy for purchase orders.

Inventory management is also an important self-discipline that the SME can employ to optimise its cash resources. The ‘just in time’ inventory can be a preferred option but it is often necessary to hold a certain level of stock, as to do otherwise can deter purchasers. Metrics exist to help the manager maintain a reasonable level of stock and these include stock to sales ratios and stock turnover.

Surviving the liquidity crisis
Cash management is vital in an environment where access to credit is difficult. Companies need to have the right tools and processes in place that enable it to monitor actual performance and produce accurate short-term forecasts. Many SMEs have had to significantly improve their cash management capabilities to survive in the current economic climate. But those that have done so will find that they are in a much better position to thrive as we begin to enter calmer economic waters.

For those wanting more information on cash flow management, CIMA has produced a guide which further explores credit and cash management in SMEs and includes advice on maximising cash inflows, managing cash outflows, extending credit and cash flow forecasting. This guide is available free of charge from https://bit.ly/aDVjsO

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