Managing Your Cash Flow

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How to make a Successful Business Even more
 Practical Working Capital Management and
          Managing Your Cash Flow
                                 Feargal McCormack
28 February 2006           
                             Telephone: 028 302 61010
                               Programme Outputs

       Enhanced Understanding of Finance

       Interpretation of Financial Statements

       An understanding of the concept of cash flow and how to develop a cash flow forecast

       Why, for businesses, CASH and not PROFIT, is king

       Why tracking and managing cash flow is critical to business survival

       Why cash flow forecasting is an important strategy

       Vital warning signs

       Sales and Cash receipts monitoring

       Working illustration

       Strategies to improve your cash flow situation
         Interpretation of Financial Statements

       Profit & Loss Account

       Balance Sheet

       Cashflow Statement

        Statutory Profit & Loss Account

        Sales

       Cost of Sales
       Gross Profit
       Other Income
       Overheads:
       Profit Before Interest & Tax
       Net Profit
       Exceptional Items
4      Dividends
     Management Profit & Loss Account

     Sales
     Variable Costs
     Contribution to fixed overheads
     Fixed overheads
     Net profit
     Breakeven point
     Margin of safety
     Importance of profitability to generate cashflow

                    Balance Sheet

       Fixed Assets

       Current Assets

       Current Liabilities

       Long Term Liabilities

       Provision for Liabilities and Charges

       Share Capital and Reserves

                       Fixed Assets

       Tangible Fixed Assets

       Intangible Fixed Assets

       Investments

       Depreciation

                     Current Assets

     Assets held for a short period of time.

     Assets that will be converted to cash within one year.

           Examples of Current Assets

     Trade Debtors:- amounts owned by customers
     Prepaid Expenses:- expenses paid in advance e.g.
     insurance, rent, rates

     Stocks:- products held for sale or to be used in the
     manufacturing process

     Work-in-progress
     Bank and Cash Balances

                  Current Liabilities

      Short-term Obligations

      Debts to outside parties due within one year

         Examples of Current Liabilities

      Trade Creditors:- money owed to suppliers generally
      will be paid in accordance with credit terms

      Taxes:- PAYE, VAT and Corporation Tax

      Bank Overdraft

      Bank / Directors Loans

      Lease / HP Creditors

      Cash Flow - Lifeblood Of Your Business

      While a business can survive for a short time without
      sales or profits, without cash it will die, so ready cash
      is the primary indicator of business health

      For this reason the inflow and outflow of cash needs
      careful monitoring and management

               What Is Cash Flow?

      The three components of cash flow:
        – Funds on hand at the beginning of any period

        – Funds received and spent during an ensuing period

        – And the funds remaining at the end of that period

         Freeing Up Profits

     “Are you Sure I Made a Profit”?

        I have less money now than

           at the start of the year

                 Cash Is NOT Profit

      Profit is the difference between the total amount your
      business earns and all of its costs, usually assessed
      over a year or other trading period

      Cash is the amount you have on hand to pay debts

      You can be showing a good profit on the books and
      still be strapped for cash to cover immediate debt

                         Cash Is King

      It’s available cash that is needed to sustain a business from

      Cash is king
     • Cash is the life-blood of any business
     • Business Managers have to keep it flowing
     • Cash Flow forecasts are a pre-requisite for business success
     • Self discipline and good management will yield positive
       results by improving profitability and reducing risks

        What’s Measured In Cash Flow?

                 Cash                        Not Cash

     Coins and notes                Long term deposits

     Current accounts and short     Long term borrowing
     term deposits
                                    Money owed by customers
     Bank overdrafts and short
     term loans                     Stock

     Foreign currency and
     deposits that can be quickly
     converted to your currency

                Freeing Up Profits

                             Company A

              P&L         Paid           Debtors       60,000

     Sales      100,000     40,000       Bank          10,000

     CoS         80,000     30,000       Creditors    (50,000)

     Profit      20,000

                                         Net assets    20,000

                             Company B

              P&L         Paid           Debtors       80,000

     Sales      100,000     20,000       Bank         (30,000)

     CoS         80,000     50,000       Creditors    (30,000)

     Profit      20,000

                                         Net assets    20,000

                        The Cash Flow Cycle

Borrowing Capacity /                           Accounts
Shareholder Input                              Receivable

                 Operating               Tax                           Sold
                 Expenses                          Plant &
                        Inventory &
     Dividends         Manufacturing                        Interest

        Cash Inflows And Cash Outflows

      Income and expenditure cash flows rarely coincide
      BUT you must always be in a position to meet your
      scheduled payments

      This means there can be times when you could simply
      NOT have enough ready cash to meet your

      Cash flow management is basically about speeding up
      the inflows and slowing down the outflows

        Key Requirements Of Your Cash

      Cash flow should have three characteristics; it should
        – Positive

        – Available

        – Timely

      To achieve this requires planning

                  Cash Flow Forecasting

      Cash flow forecasting enables you to plan for:
        – How much cash your business will need to keep trading

        – When it will be needed

        – Applying for financing if there is going to be a shortfall

        – Managing excess funds

      Elements Of A Cash Flow Forecast

      Receipts

      Payments

      Excess of receipts over payments - with negative
      figures shown in brackets

      Opening bank balance

      Closing bank balance

               Using The Forecast

      A cash flow forecast will assist you to structure
      your business’ policies for working capital
      management to meet your cash needs, or work
      with your accountant to apply for financing

                   Improving Cash Flow

      To improve cash flow you need to work on the drivers
      of cash flow:
        – Receivables

        – Suppliers

        – Inventory

        – Assets

        – Costs

        – Trading pattern

        – Trading volume

              Debtors Management Control


     Companies can accelerate monies due from debtors by following a
     few Simple steps:
        Review debtors list and establish baseline position

        Agree Terms of Business including payment terms in advance

        Establish credit practices as a matter of company policy

        Establish limits for each category of customer - never allow
         exposure to slip beyond these limits

        Constantly review the limits when times are tough or to
         customers in weak industries

        Agree up front payments or payments on completion of

26      Assign person with responsibility for the collection of debtors
              Debtors Management Control

        Use credit agencies and bank references before you actually engage in
         business with potential new customers;
        Secure guarantees for large credit limits;
        Consider charging interest on overdue accounts;
        Consider accepting credit cards or smart cards as a payment option;
        Sales credit insurance to be considered;
        Option of invoice discounting to be considered;
        Set up direct debits / standing orders for regular customers;
        Consider offering discounts for early payment of invoices;
        Consider factoring debtors;
        Example decrease debtor days; and
        STOP further sales on overdue accounts.

           Debtors Management Control

     If your average age of your debtors is worse as the point of
     review that it has been for some time you may need to look at
     some of the following telltale signs:

      Weak credit judgement
      Poor collection procedure
      Not enforcing
      Slow issue of statements
      Customer dissatisfaction

             Debtors Management Control


     Some of the key indicators about a potential bad debt problem include:

        Longer credit terms taken without approval followed by smaller

        The issue of post-dated cheques by debtors who normally settle
         within terms

        Evidence of regular switching to different suppliers for the same

        New customers who are reluctant to give credit references

        Receiving round sum payments from debtors

          Creditors Management Control

      Who authorises purchasing in your company?      Is it tightly
      managed or spread among a number of people

      Is there a formal purchase order system in place
      Do you know the cost to the company of carrying stock?
      Do you have alternative sources of supply?
                                               If not, get
      quotes from major suppliers and shop around for the best

      How may suppliers have a return policy?
      Are you in a position to pass on cost increases quickly with
      price increases to your own customers?
         Creditors Management Control

      If a supplier of goods or services lets you down can
      you charge back the cost of the delay?

      Can you arrange to have delivery of supplies

      Possibility of consignment stock terms

      Consider Reservation of Title

               Stock Management

     The principal factors that need to be considered in

     determining the Optimum stock level include:

      Projected sales levels
      Availability of raw materials/stock
      Lead time required by suppliers
      Length of production process
      Efficiency of distribution
               Stock Control Procedures

     For better stock control measurements try the following:

      Carry out physical stocktakes on at least a six monthly

      Know the number of times each major item of your stock
      turns in a year

      Consider selling off outdated or slow moving
      merchandise, it will only get more difficult to sell if you
      keep it

      Analysis stock by product – 80% of profit is generated by
      20% of products
             Stock Control Procedures

      Consider having part of your product out-sourced to
      some other manufacturer rather than make it yourself
      low profit items – opportunity lost?

      Review your security requirements to ensure no stock
      is going out the back door

      Review production process and eliminate bottlenecks
      which delay delivery

               Strategy: Manage Assets

      As a general rule, you should try to finance your
      operations out of working capital

      If your business needs to purchase an expensive
      machine or other fixed asset, match repayment period
      to the expected lifetime of the equipment

            Strategy: Manage Costs

      In 99% of cases, there are some (sometimes
      significant) savings to be made that will improve
      the cash flow situation

        Strategy: Manage Trading Pattern

      Uneven income distribution due to seasonal demand
      or whatever, can lead to peaks and troughs in the cash

      Try to even out the income flow through:
        – Market to sell more in the ‘trough’ periods

        – Encourage non-urgent customers to wait for goods and services
          until a slower time of year

        – Vary pricing to encourage demand

                        Cashflow Planning

     If cash flow shows an additional requirement beyond original
     expectations, consider the following:

      In short term encourage payment of debtors (focus on cash
       collection or cash discounts etc)

      Negotiate additional credit from suppliers
      Reduce level of raw materials or finished goods and sell off
       obsolete stock

      Talk to your local bank in advance about additional credit
       accommodation to maintain credibility

                   Cashflow Planning

      Seek additional support from shareholders

      Reduce, defer or even consider cancelling drawings,
      dividends or other payments to shareholders or

      Increase your trade credit by agreement to support
      additional sales

      Consider debtor factoring

      Consider outside equity or a business angel
                    Cashflow Planning

     Conversely, if you expect to generate surplus cash, consider:

      Making more regular lodgements to your overdraft
      (reducing interest bill)

      Seeking better discount for early or cash payments to

      Examining short term investment opportunities

          Strategy: Manage Trading

      Overtrading can result in major cash flow

               Borrowing As A Strategy

      Two common ways in which many businesses get
      over a cash flow crisis
        – Borrow

        – Put more of the shareholder’s money into the business.

      These are acceptable for coping with short term
      constrictions, or to fund growth in line with your
      business plan, but shouldn't form the basis of your
      cash strategy

          Measuring Your Performance

      If you work on your drivers you need also to monitor
      those drivers on a regular basis to see how you are
      going – if you are achieving what you planned for

      There is always the opportunity to be better.If you’re
      not monitoring your actual results regularly, you can’t
      capitalise on any opportunities that improved cash
      flow might offer.

      What you can measure, you can manage

                        Vital Warning Signs

     Since you cannot measure everything all of the time, pick out the “vital
     signs” that are relevant to your business and plot them over a period. If
     there is a sudden change in a trend look for the root cause and take
     immediate corrective action before it is too late.

     Examples of vital signs would be:

      Pre-tax profits as a percentage of sales
      Gross profit margin
      Bad debts (number and amount)
      Debtor Profile
      Stock Turnover
                  Vital Warning Signs

      Goods returned
      Complaints from customers
      Staff turnover
      Absenteeism
      Downtime
      Accidents in the work place
      Business Quoted/lost/won
      Level of bank debt
      Level of repeat business

       Cash Flow Key Performance Indicators

      There are a number of key performance indicators
      (KPIs) that will indicate, on their own or in
      association with other KPIs, how the business is
      performing with regard to the drivers of cash flow e.g.
       – Inventory turnover

       – Days receivable

       – Days payable

        Steps To Developing And Monitoring
                    Your KPI’s

      Determine what needs to be monitored in your
      business (your KPIs)

      Input actuals and compare them to your plan, either
      monthly or some other period

      Identify where they vary from the plan

      Take corrective action as needed

                   Monthly Sales and Cash Receipts
                     Monitoring Y/E 30/04/04
                               NET FEES ISSUES                      CASH COLLECTED
                                                                      (Net of VAT)
                      Budget       Actual        P/Y y/e   Budget        Actual      P/Y y/e
                                   30/4/06       30/4/05                 30/4/06     30/4/05
     May 2005
     June 2005
     July 2005

     August 2005
     Sept. 2005
     Oct. 2005
     Nov. 2005

              Monthly Fees Control

     Client    Budgeted   Actual   Variance   Comment


     Monthly Cash Receipts Control

     Client   Budgeted   Actual   Variance   Comment



      More businesses fail because of poor cash flow than
      because of poor profit

      Cash flow should be planned and managed


     FPM – A Client Focused Practice



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