SMALL BUSINESS FINANCIAL MANAGEMENT MANAGING CASH FLOW Cash has become a big problem for many small

and even big businesses today. Lack of it has driven numerous small and even big businesses into bankruptcy. Unfortunately many more small businesses will become bankrupt because their owners have neglected the principles of cash management which normally determines their success or failure. Cash is like oxygen to a business. When it is there, it is taken for granted but in its absence, death of the business comes quickly. Developing cash forecast is essential for new businesses because early sales do not generate enough cash to keep the company afloat. Managing cash effectively requires an entrepreneur to look beyond focusing on their income statement and balance sheet and focus on what it takes to keep a company going which is cash The Importance of Cash Management to the Success of a Small Business Managing cash flow which is a struggle for many business owners involves: Forecasting, Collecting, Disbursing, Investing and Planning for the cash a company needs to operate smoothly. A business must have enough cash to meet its obligations as they come due or it will experience bankruptcy. Creditors, employees and lenders expect to be paid on time, which requires cash. Proper cash management permits entrepreneurs to adequately meet the cash demands of their businesses, avoid retaining unnecessarily large cash balances and stretch the profit-generating power of each cedi or dollar their companies own. Entrepreneurs must have the discipline to manage cash flow from their first day of operations. Although cash flow problems affect all companies, young businesses are more prone to suffer cash shortages because all the available cash is used for productive activities and their cash generating activities have not reached the level to generate enough cash to cover rapidly growing expenses. A study of successful businesses conducted by Geneva Business Bank found that the greatest potential threat to cash flow occurs when a company is experiencing rapid growth. If sales are up, the owner must also hire more employees, expand plant capacity, develop new products, increase sales force and customer service staff, build inventory and incur other drains on the firms cash supply. However, collections from the increased sales often lag behind as the

company grows and the result is a cash crisis. Unfortunately, many small businesses do not engage in cash planning. Another study found that many small business owners do not engage in cash planning and that out of 2,200 small businesses studied, 68% performed no cash flow analysis at all. The result is that many successful, growing and profitable businesses fail because they become insolvent as they do not have adequate cash to meet the needs of their growing business with a booming sales volume Small business owners dont understand that if they are successful, stock and receivables will increase faster than profits can fund them. The resulting cash crises may force an entrepreneur to lose equity control of the business or ultimately declare bankruptcy and close. Cash Management Roles of the Entrepreneur The five key cash management roles every entrepreneur must fulfill are: 1. Cash Finder- This is the entrepreneurs first and foremost responsibility. Must make sure there is enough capital to pay all present and future bills. This is not a one-time task but an ongoing job 2. Cash Planner- As a cash planner, an entrepreneur makes sure the companys cash is used properly and efficiently. Must keep track of its cash, make sure it is available to pay bills and plan for its future use. Planning requires one to forecast the companys inflows and outflows for the months ahead with the help of a cash budget. 3. Cash Distributor- This role requires entrepreneur to control the cash needed to pay the companys bills and the priority and the timing of those payments. Forecasting cash disbursements accurately and making sure the cash is available when payments come due are essential to keeping the business solvent. 4. Cash Collector This role requires the entrepreneur to make sure customers pay their bills on time. Too often, entrepreneurs focus on pumping up sales whiles neglecting to collect the cash from those sales. Having someone in ones business to collect accounts receivable is essential. Uncollected accounts drain a small companys pool of cash very quickly. 5. Cash Conserver This role requires the entrepreneur to make sure the company gets maximum value for the dollars it spends. Avoiding unnecessary expenditures is an important part of this task. The goal is to spend cash so it will produce a return for the company The first step in managing cash more effectively is to understand the companys Cash Flow Cycle. What is the Cash Flow Cycle?

This is the time lag between paying suppliers for merchandise and receiving payment from customers. The longer this cash flow cycle, the more likely the business owner is to encounter a cash crisis. Preparing a cash forecast that recognizes the cash flow cycle helps to avoid a cash crisis. Cash and Profits Are Not the Same When analyzing cash flows, entrepreneurs must understand that cash and profits are not the same. Profits or net income is the difference between a companys total revenue and its total expenses. It measures how efficiently the business is operating. Cash is the money that is readily available to use in a business Cash flow measures a companys liquidity and its ability to pay its bills and other financial obligations on time by tracking the flow of cash into and out of the business over a period of time. Flow of Cash through a Typical Business Decreases in cash occur when a business purchases on credit or for cash the following: 1. Goods for inventory (stock) or 2. Materials for use in production The resulting inventory is sold either for cash or on credit. When a company receives cash or collects accounts receivable, a companys balance increases. Purchases for stock/inventory and production precede sales. These bills must be paid before sales are generated However, collection of accounts receivable lags behind sales so customers who purchase goods on credit may not pay until a month or much later. Though profits are important, business owners do not pay creditors, employees and lenders in profit but with cash. Thus cash flow is more important than earnings/profits. Although profits may be tied up in many forms like inventory and machinery, cash on the other hand is the money that flows through a business in a continuous cycle without being tied up in any other asset. A company can operate in a short run with a net loss on its income statement but if its cash flow is negative, the business is in real trouble since it will be unable to pay suppliers, meet payroll demands, pay taxes or any other bills and consequently the business is headed for extinction. Cash Budgets There is the need for reliable cash forecast in every business because, the cash inflows to a business is rarely in sync with its cash outflows. Uneven cash flow creates periodic surpluses and deficits. Entrepreneurs thus need to track the flow of cash through their businesses to project

realistically the cash available throughout the year. Many businesses operate without knowing the pattern of their cash flows, thereby disregarding an essential process of cash management. Entrepreneurs must ensure an adequate but not excessive supply of cash on hand to meet companies operating needs. A business owner should prepare a Cash Budget. A Cash Budget is a cash map showing the forecast of the amount and timing of the cash receipts and the cash disbursements day by day, week by week or month by month. It is used to predict the amount of cash the firm will need to operate smoothly over a specific period of time. It is a valuable tool in managing a company successfully. It has been found out that entrepreneurs who take time to prepare a cash budget are less likely to encounter a cash crisis and more likely to keep their companies solvent. Preparing a Cash Budget A small business should typically prepare monthly cash budgets for at least one year and quarterly estimates one or two years beyond that. To be effective, a cash budget must cover all seasonal fluctuations. The more variable a companys sales pattern, the shorter its planning horizon should be. Example: Firms whose sales fluctuate widely over a short time frame might require a weekly cash budget. The key to managing cash flow successfully is to monitor the inflows and out flows as well as the timing of those cash flows A cash plan must be in writing for an entrepreneur to properly visualize a companys cash position. Computer spreadsheets such as Excel and Lotus make cash budgets a fast job, easy to complete and allow instant updates. Cash budgets are based on cash method of accounting where cash receipts and cash disbursements are recorded when cash transactions are expected to take place Because depreciation, bad debt expense and other non-cash transfers involve no cash transfers, they are omitted from cash budgets. What is a Cash Budget? It is a forecast of the firms cash inflows and outflows for a specific time period. It is never completely accurate but it gives a small business owner a clear picture of a companys estimated cash balance for the period pointing out where external cash infusions may be required or where surplus cash balance may be available for investing. Also by comparing actual cash flows with projections, entrepreneurs can revise their forecasts so the future cash budgets will be more accurate. There are 5 steps in creating a cash budget: 1. Determining an adequate minimum cash balance

2. Forecasting sales 3. Forecasting cash receipts 4. Forecasting cash disbursements 5. Estimating the end-of-month balance 1. Determining an Adequate Minimum Cash Balance There is no reliable method for determining cash balance. Though some suggest the firms cash balance should be equal to at least one-forth of its current debts, this does not work for all small businesses. The most reliable method of determining the cash balance is based on past experience. Past operating records should indicate the proper cash cushion needed to cover any unexpected expenses after all normal cash outlays are deducted from the months receipts. Example: Past records may indicate that it is desirable to maintain a cash balance equal to five days sales. 2. Forecasting Sales This is the heart of the cash budget. It is the central factor (referred to as principal factor) in creating an accurate picture of a companys cash position because sales ultimately are transformed into cash receipts and cash disbursements. For most businesses, sales constitute the major source of cash flowing into the business. Thus the cash budget is as accurate as the sales forecast from which it is derived. An accurate sales forecast is essential to producing a reliable cash flow forecast For established businesses, the sales forecast is based on past sales but owner must be careful not to be excessively optimistic projecting sales and overestimate sales. This is because economic swings, increased competition, fluctuations in demand and other factors affect sales. Several quantitative techniques like linear regression, multiple regression, time series analysis and exponential smoothing are used for forecasting sales. These methods enable small business owners to extrapolate past and present sales trends to arrive at fairly accurate sales forecasts. The forecasting of sales for new businesses is difficult if not impossible and thus entrepreneur might conduct research on similar firms and their sales patterns in their first year of operation to come up with a forecast. Trade associations and local chambers of commerce in various industries collect such information which can be used by new businesses. Market research is another source of information used to estimate annual sales for new firms. Other potential sources that may help predict sales include Census Bureau reports, newspapers, radio and television customer profiles, polls and surveys and local government statistics. No matter what small business managers use to obtain sales, it must be realized that these estimates could be wrong. Thus many financial analysts suggest that owners create three estimates namely

an optimistic, a pessimistic and a most likely sales estimate. Then a separate cash budget for each is forecast. This helps entrepreneurs to determine the range within which their sales and cash flows will likely be as the year progresses. 3. Forecasting Cash Receipts Sales constitute the major source of cash receipts. When businesses sell goods and services on credit, the cash budget must account for the delay between the sale and the actual collection of the proceeds. Example: Sales made on credit in February may not be collected till March or April. To project accurately a firms receipts, an entrepreneur must analyze the accounts receivable to determine the collection pattern. Example: Past records may indicate that 20% of sales are for cash, 50% are paid in the month following the sale, 20% paid two months after sale, 7% after three months and 3% are never collected. Receivables act as sponges tying up capital until the entrepreneur collects them In addition to the cash and credit sales, a cash budget must include any other cash the company receives such as interest income, rental income, dividends etc 4. Forecasting Cash Disbursements Most owners of established businesses have a clear picture of a companys pattern of cash disbursements. The key factor in recording disbursements for a cash budget is to record them in the month in which they will be paid not when the debt or obligation is incurred. Example of cash disbursements/payment of businesses include purchases of inventory or raw materials, wages and salaries, rent, taxes, insurance premiums, loans and interest, selling expense, overhead expenses and miscellaneous expenses. A common tendency is to underestimate cash disbursement which can result in cash crisis. To prevent this, wise entrepreneurs and especially new business owners should cushion their cash disbursement account by making it higher than expected and adding about 25% 50% of the total. Whatever forecasting technique an entrepreneur uses, the key is to avoid underestimating cash disbursements which may lead to severe cash shortages and possibly bankruptcy. 5. Estimating the End of Month Cash Balance To estimate a companys cash balance at the end of month, an entrepreneur must first determine the cash balance at the beginning of each month. The beginning cash balance includes cash on hand as well as cash in current and savings accounts. The owner simply adds projected total cash receipts for the month and subtracts projected total disbursements to obtain the end of month balance before any borrowing takes place.

A positive amount indicates that the business has a cash surplus for the month while a negative amount shows a cash shortage will occur unless the entrepreneur borrows or collects additional funds. Normally, a companys cash balance fluctuates from month to month reflecting seasonal sales patterns. A trend of increases in cash indicates a small firm has enough cash that could be placed in some income-earning investment. A trend of decreasing cash should alert the owner that the business is approaching a cash crisis. Preparing a cash budget illustrates the flow of cash into and out of the small business. It also enables a business owner to anticipate cash shortages and cash surpluses. By planning cash needs ahead of time, an entrepreneur is able to do the following: 1. Increase the amount and the speed of cash flowing into the company 2. Reduce the amount and the speed of cash flowing out of the business 3. Develop a sound borrowing and repayment program 4. Impress lenders and investors with the ability to plan and repay loans 5. Reduce borrowing costs by borrowing only when necessary 6. Take advantage of money-saving opportunities such as economic order quantities and cash discounts 7. Make the most efficient use of the cash available 8. Finance seasonal business needs 9. Provide funds for expansion 10. Plan for investing surplus cash The message is simple. Managing cash flow means survival for a business. Businesses tend to succeed when their owners manage cash effectively. Those who neglect cash flow management techniques are likely to see their companies fold up The Big Three of Cash Management By concentrating on the 3 primary causes of cash flow problems, small business owners can dramatically lower the likelihood of experiencing a devastating cash crisis. The big three of Cash Management are: a. Accounts receivable

b. Accounts payable c. Inventory 1. Accounts Receivable Selling goods and services on credit is a necessary evil for most small businesses. Selling to customers on credit could be expensive. It requires more paperwork, more staff and more cash to service accounts receivable. Every business owner who sells on credit will encounter late paying customers and those who will not pay at all. Because many entrepreneurs sell on credit, an assertive collection program is essential to managing a companys cash flow. Extending credit is described to be a double edged sword. A credit policy that is too lenient can destroy a business cash flow. However, a well designed credit policy can be a powerful selling tool attracting customers and boosting cash flow How to Establish a Credit and Collection Policy The First Step is to screen customers carefully before granting credit. The first line of defense against bad debt loses is a detailed credit application. A business owner should have customer to fill out customizes application designed to provide information needed to judge the potential customers creditworthiness. This should provide the following: Name, address, telephone number, form of ownership (proprietorship, partnership etc) and number of years in business, credit references e.g. other suppliers including contact names, addresses and telephone numbers, bank references. After collecting this information, the business owner can use this to check potential customers credit references. The Second Step involves establishing a firm written credit policy and letting every customer know in advance the companys credit terms. The credit agreement must be in writing and should specify a customers credit limit and any deposits required. It should state clearly all the terms the business will enforce if the account goes bad including interest, late charge charges, attorneys fees etc. Failure to specify these terms in the contract means they cannot be added later after problems arise. The Third Step in an effective credit policy is to send invoices promptly because customers rarely pay before they receive their bills. The sooner a company sends out invoices, the sooner the customer will send payment. Small businesses owners can take several steps to encourage prompt payment of invoices. 1. Ensure that all invoices are clear, accurate and timely.

2. State clearly a description of the goods or services purchased and an account number if possible. 3. Make sure that prices on invoices agree with the price quotations on purchase orders or contracts. 4. Highlight the terms of sale on all invoices. 5. Include telephone number and a contact person in your organization in case the customer has a question or a dispute. 6. Respond quickly and accurately to customers questions about their bills. When an account becomes overdue, a small business owner must take immediate action. The longer an account is past due, the lower the probability of collecting it. As soon as an account becomes overdue, many business owners send a second notice requesting immediate payment. If that fails to produce results, the next step is a telephone call, normally a day after the payment is due. If the customer still refuses to pay bill after 30 days, collection experts recommend the following: 1. Send a letter from the companys attorney 2. Turn the account over to a collection agency 3. Hire a collection attorney Techniques for Accelerating Accounts Receivable Small business owners can rely on a variety of techniques to speed cash inflow from accounts receivable: 1. Speed up orders by having customers fax them to you 2. Send invoices immediately goods are shipped rather than a day or a week later- this may be done by faxing or e-mailing invoices to reduce in-transit time to a minimum. 3. Indicate in conspicuous print or colour the invoice due date and any late payment penalties imposed. 4. Deposit customer checks daily. 5. Identify the top 20% of your customers by sales volume and create a separate file system for them and monitor them closely.

6. Restrict the customers credit until past due bills are paid. 7. Ask customers to pay a portion of the purchase price upfront. 8. Watch for signs that a customer is about to declare bankruptcy which includes late payments from previously prompt payers and unreturned calls concerning late payments are usually first signs that a customer may be heading for bankruptcy. 2. Accounts Payable This is the second element of the Big Three of Cash Management. The timing of payables is as crucial to the proper cash management as the timing of receivables though its objective is exactly opposite. An entrepreneur should strive to stretch out payables as long as possible without damaging the companys credit rating. Small business owners should regulate their payments to suppliers and vendors to their companys advantage. Even when cash flow is not the best, efficient cash managers should set up a payment calendar each month so bills are paid on time and take advantage of cash discounts for early payment. Business owners should verify all invoices before paying them as some unscrupulous suppliers will send out invoices for goods they did not supply this must be done by the accounts payable clerk. Small business owners must take advantage of cash discounts by paying early. Clever small business owners should negotiate the best possible credit terms with their suppliers as most suppliers grant their customers trade credit. When entrepreneurs are financially strapped when payment is due, they should discuss this openly with their suppliers instead of making empty promises. Small business owners can also improve their firms cash flow by scheduling controllable disbursements such that they do not come due at the same time. Example, scheduling insurance payments monthly or quarterly rather than annually may improve cash flow. 3. Stock or Inventory This is a significant investment in small businesses and can create severe strain on cash flow if not properly managed. Some small businesses hold very large quantities of inventory that siphons of a companys cash. Tracking inventory consistently enables a business owner to avoid purchasing too much goods. Marking down inventory items that do not sell will keep inventory lean and allow it to turn over frequently. Efficient cash management calls for businesses to commit just enough cash to inventory to meet demand. Scheduling inventory deliveries at the latest possible day will prevent premature payment of invoices. For goods of comparable quality and price, entrepreneurs should purchase goods from those suppliers who are best at making fast frequent deliveries to keep inventory levels low.

Monitoring the big three of cash management can help every business owner avoid cash crisis while making the best use of the cash available. According to an expert, maximizing cash flows involves getting money from customers sooner, paying bills at the last moment possible, consolidating money in a single bank account, managing accounts payable, accounts receivable and inventory more effectively and squeezing every penny out of ones daily business. Avoiding the Cash Crunch 1. Bartering the exchange of goods and services for other goods and services is an effective way to conserve cash 2. Trimming Overhead Costs this involves the following: a. When practical, lease instead of buying. By leasing automobiles, computers, office equipments, machinery and other assets rather than buying them, entrepreneurs can conserve valuable cash. Leasing avoids large capital outlays and allows companies to stretch payments over long periods. b. Avoid non-essential outlays example, avoid ostentatious office equipment, first class travel and flashy company cars. Business owners can make efficient use of company cash. One common mistake made is cutting marketing and advertising during business slowdowns. c. Negotiate fixed loan payments to coincide with your companys cash flow cycle. Many banks allow businesses to structure loans so that they can skip specific payments when their cash flow gets to its lowest point example, winter time. d. Buy used or reconditioned equipment especially if it is behind the scenes machinery. e. Look for simple ways to cut cost smart entrepreneurs always lookout for ways to cut cost of operating their businesses every day. One useful way is to sit down with employees periodically with a list of company expenses and brainstorm ways the company could conserve cash without endangering product quality or customer service f. Hire part-time employees and freelance specialists whenever possible saves cost of salaries, employee benefits, insurance etc g. Control employee advances and loans manager should grant loans that are necessary and should keep records on payments and balances h. Establish security and control systems to reduce employee theft e.g. monthly reconciliation statements, separating record keeping and check writing responsibilities instead of assigning them to a single employee offers more protection i. Develop a system to battle cheque fraud bounced cheques

j. Change shipping terms from FOB (free on board) buyer in which seller pays the cost of freight to FOB seller in which the buyer absorbs all shipping costs improves cash flow. 3. Investing Surplus Cash this immediately yields much returns instead of leaving temporary surpluses to sit there idle. Investing surplus cash maximizes the firms earning power. Investing any surplus should only be done if the business identifies amounts to be used in paying bills and setting aside such monies. A cash Budget is detailed statement of expected receipts and payments of cash during the next year. Cash budgets are divided into shorter time periods or control periods; quarterly, monthly or even weekly to suit the requirements of the organization. Cash budgets one of the most important budgets, receives close attention in every cash organization. Cash is vital to pay wages and salaries and buy materials etc. Cash budget shows expected cash position for each of the periods ahead. Enables organization to assess whether operations can continue as planned or whether they need to be curtailed, whether need to approach bank for a loan etc. The cash flow for a period does not equal the profit for a period since it is possible for a profitable company to have shortage of cash. The Cash Budget or Budgeted Statement of Cash Receipts and Disbursement may be prepared once management has prepared the sales, production, material usage and purchases, direct-labour and overhead budgets as well as a list of anticipated acquisitions and dispositions of fixed assets, dividend and interest payments to investors, proceeds from new financing and outflows from long-term debt retirement and stock repurchasing. Cash Budget may be considered as the most important part of the master budgeting process. The Most Important Sections Of The Cash Budget Are: a. Total Cash Available before Current Financing In general this is equal to the beginning cash balance, collections from customers (from sales budget), proceeds from new financing, proceeds including interests from marketable securities and proceeds from dispositions of longterm assets. b. Total Disbursements This is equal to the cash outflow from operations c. Total Cash needed equal to total disbursements and a minimum cash balance the firm wants to keep as a security. d. Excess or Deficit of Cash equals to the total cash available before current financing minus the total cash needed. e. Total Effect of Financing This equals to the amount borrowed in cash of a cash deficit, the interest and principal repaid in case of an excess of cash. Contents of Cash Budget

A Cash Budget must include every type of cash outflow and cash receipt. In addition to the amounts, the timings of all receipts and payments must be forecasted. Examples of Typical Receipts and Payments include: 1. Typical Receipts Include: a. Cash Sales b. Receipts from Debtors (i.e. arising from credit sale) c. Receipts of interests or dividends d. Issue of new shares 2. Typical Payments/Disbursements Include: a. Cash Purchases b. Payments to creditors for stock and material purchases on credit c. Wage/salary and bonus payments d. Payments of Fixed assets e. Payments for overhead and expense items f. Payments of Dividends Interests and Tax 1. Profit is derived using rules and conventions. Normally it does not equal the cash flow Budgetary Control This is the process of comparing actual costs with budgeted costs on a regular basis usually monthly. Variances are calculated and reports showing budget, actual and variances if any are produced for every manager responsible for a budget and in summary form for higher management. In order to show realistic cost allowances, flexible budgeting must be used. The aim of budgetary control is to highlight variations from the plan so that corrective action can be taken to bring operations back into line with plan, but in the case where circumstances have changed drastically, to make adjustments to the plan. Controllable and Non-Controllable Costs Budgetary control reports for a manager should show only costs for which he is accountable and which are under his control. These are known as controllable costs. Costs which a manager has no control over are known as non-controllable and would not normally appear on a managers

budgetary control report. The primary objective of budgetary control is to serve as a trigger for corrective action. Budgetary Control Reports This is an important part of the control process. Its purpose is to initiate effective action so its design, content, and timing must be carefully considered. Key item shown are; a. The budgeted costs and revenues for the period and year to date (YTD) b. The actual costs and revenues for the period and YTD c. The variances between a) and b) together with trends in the variances d. An indication of whether the variance is of sufficient size to be considered significant. Budgetary control reports are often detailed and show the above items for each of the costs for which the manager is responsible.