Cash flow management
Cash flow is...
An organization’s cash inflows and outflows from its three main activities -operating (or
trading), investing and financing:
Activity |
Main cash inflows |
Main cash outflows
|
Operating |
Sales revenue |
Operating expenses (e.g. wages and supplies). Tax and interest paid.
|
Investing |
Sale of fixed assets, subsidiary companies and financial investments. Interest
and dividends received. |
Purchases of fixed assets, subsidiary companies and financial
investments.
|
Financing |
Share sales and new loans |
Dividends paid and loan repayments |
These inflows and outflows are all included in an organization’s cash flow statement that all companies must
publish (see financial accounting). For the year ended 22
February 2014 the key items in the British supermarket Tesco’s cash flow statement
were:
£million
Net cash (i.e. inflows less outflows) from operating activities |
3,185
|
Net cash used (or spent) in investing activities |
(2,854)
|
Net cash from financing activities |
56 |
Net increase in cash |
387 |
Cash shortages arise from...
Insufficient working capital i.e. current assets (cash or easily convertible into cash) less current liabilities
(unpaid debts). This results from over-investment in fixed assets (like property and equipment kept for over a
year).
The Working Capital Cycle
The working capital cycle shows how working capital (including cash) circulates around a business.
This cycle will look like:
Problems of a cash shortage
1. Credit
Difficulty of obtaining credit from suppliers because of the bad feeling caused by delayed payment.
2. Discounts
Inability to take advantage of cash discounts.
3. Financial reputation
Damage to a firm’s standing in the eyes of potential investors and lenders which will make it more difficult to
raise future finance.
4. Profits
Inability to pay for supplies and profitable investment opportunities like new products.
5. Borrowing and asset sales
Possible necessity of having to borrow or sell assets.
6. Liquidation
Possibility of going out of business.
How to avoid a cash shortage
1. Raise
money – from:
- owners (e.g. selling shares).
2. Delay
payment for purchases
e.g. credit purchases, hire purchase and leasing (renting equipment).
3. Selling
fixed assets
You can lease them back under a scheme called sale and lease back.
4. Factoring
A finance company buys the debts of your credit customers (or debtors) and becomes responsible for collecting
them.
5. Stock control
Making sure you have enough stocks (e.g. raw materials and goods to sell) without having too many.
Just-In-Time minimizes stocks by getting them delivered only when they’re needed.
6. Credit control – making sure your credit customers pay up.
7. Creditor control – delaying payment to suppliers for as long as possible.
8. Check liquidity ratios (see analysing accounts):
- current ratio: current assets ÷ current liabilities.
- liquid (or quick, or acid test) ratio: (current assets less stocks) ÷ current
liabilities.
9. Use a cash flow forecast (sometimes called a cash budget)
This shows an organization’s monthly planned cash incomes and expenditures for a period of
time (usually a year). It will show any future cash shortages, so that any appropriate action can be taken.
Key quotes
explained
“Customer satisfaction, employee satisfaction and cash
flow”,
- Jack
Welch (General Electric’s ex-boss, pictured right) on the three most important measures of
company performance.
Notice Welch doesn’t mention profit, because it is automatically created by customer and employee
satisfaction.
“Cash before conscience!”,
- Horace (Roman poet, pictured right).
Principles may be lost in the dash for cash.
“The cheque is in the
post”,
- Richard
Branson, pictured right (his favourite phrase in the cash strapped early years of
his company, Virgin).
|