Effective Cash Management Can Give Firms an Edge

Entrepreneur's Notebook
by Steve Cleland

Raising corporate capital has always been a challenge, but it is especially difficult now, when money isn't easily available. So before you begin pounding your head against the wall looking for capital, it is best to look inward.

Begin with an effective cash management plan that predicts the careful timing of your company's cash in-flow and out-flow. This includes cash flow projections, timing of receipts and disbursements and the efficient handling of any excess cash through investment or debt service.

There are two levels of cash management: macro, or cash flow budgeting; and micro, covering collections, disbursements and investing.

The cash management process starts with a cash flow budget for the year, which presents the company's cash needs on a month-to-month basis. If your cash flow is tight or you go through cycles within months, establishing criteria for evaluating cash flow requirements is essential.

To prepare the cash flow budget, you will need to formulate assumptions based on recent history and future expectations of sales, purchases, collections, payments and capital requirements for items such as property, plant and equipment, tax payments and bonuses.

When it comes to collections, keep in mind that it may take a little longer or require additional effort to collect amounts receivable in a tighter economy.

Once the cash flow budget is complete, look at the expected results and plan for investment of excess cash or for any anticipated deficits. Among the options for covering an expected deficit are seeking financing or trimming expenses. The last thing you want is to surprise your lender with an immediate need for capital.

This is the time to reevaluate your expenses and make necessary cuts. It is important to review your cash budget on a regular basis and be sure it parallels actual results, reflecting changes in assumptions and circumstances.

Trimming the cycle

When examining your collection process, the goal is to reduce the collection cycle the time between a sale and your actual cash receipt deposit in the bank. To achieve this goal, you need to focus on three areas: invoicing, collection and the bank deposit process.

Invoicing timeframes vary greatly from one industry to the next in manufacturing it's normally done daily, while the service sector often invoices weekly or monthly and it is important to invoice as frequently as possible. Billing terms should encourage payment within the shortest possible time and should be clearly marked on invoices.

A small discount to reward early payment is much less costly than following up on an unpaid receivable, while an interest penalty for overdue accounts provides an offset incentive.

Quicker payments are also encouraged because in the first three months successful collection of payments is reduced by more than 25 percent, in six months this can increase to approximately 60 percent and in the first year by more than 70 percent.

Depositing the day's receipts on a timely basis Dependingmay be accomplished simply through more frequent trips to the bank. Depending on the size and volume of checks your business processes, a useful tool may be to have customers send all payments to a separate post office box, which the bank empties several times a day. This cuts processing time and reduces administrative tasks.

The key to effective cash management on the disbursement side is to maximize the time between the purchase of and payment for a product or service.

If you establish a good control system for disbursing funds, you can eliminate duplicate purchases, reduce inventory costs and take advantage of purchase discounts.

Track the cash

Once excess cash has been identified in your budget, you need to decide what the best use of the funds would be. You can either repay debt or invest the funds in an income-producing asset.

In many cases, reduction of debt is the best and most simple use of idle cash. Interest rates are normally higher on debt than on low-cost investments and additional fees are usually not levied for paying debt down.

Set an investment policy establishing investment objectives, the required liquidity of the investments, types of desired investments, and the expected risk and return.

At a minimum, companies with cash surpluses during the year should utilize a corporate sweep account where cash is transferred from non-interest bearing checking accounts to a money-market account on a daily basis.

Cash flow is something that should be closely monitored no matter what type of business you're in or how well the economy is doing. It will protect your business during slower times, and the increased efficiency will give you a competitive edge when the economy resumes its upswing.



Steve Cleland is a principal at RBZ LLP, an accounting and consulting firm in Los Angeles.

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