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Max Gross,
Chapter 570 Chair
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CASHFLOW ANALYSIS
UNDERSTANDING CASH FLOW
To be competitive, small business owners must plan and prepare for all future
events and market changes. Possibly the most important aspect of preparation
is effective cash-flow planning. Failure to properly plan cash flow is one of
the leading causes for small business failures in the United States.
Experience has shown that many small business owners lack a general
understanding of accounting principles. For this reason, a few of the basic
principles will be covered. There also are self-instructional guides from
which you can obtain a better understanding of accounting.
THE BASICS
Cash in business serves several purposes. First, it is used for meeting
normal cash obligations (i.e., paying bills). Second, it is held as a
precautionary measure for unanticipated problems. Third, it is held for
potential investment purposes. The term "cash" refers to:
Cash
Checks
Checking
Accounts
THE OPERATING CYCLE
The operating cycle can be defined as the system through which cash
flows, from the purchase of inventory through the collection of accounts
receivable. It measures the flow of assets into cash and is, in effect, a
"business stopwatch." For example, the operating cycle may begin
with both cash and inventory on hand. Additional inventory is purchased on
account to work as a cushion for future sales to guarantee that you will not
deplete your stock. Except for cash sales, when some of your inventory is
sold, accounts receivable increase, but your cash doesn't. Typically, you pay
for the inventory you have purchased thirty days after it is received. When
the payment for inventory is made, both cash and accounts payable are
reduced. Thirty days after the sale of inventory, receivables are usually
collected, which increases cash. Now your cash has completed its flow through
the operating cycle and is ready to begin again.
CURRENT ASSETS
Cash and other balance sheet items which convert into cash within
twelve months are referred to as current assets. Typical current assets are:
Cash
Marketable
Securities Receivables
Pre-Paid
Expenses
A
Plan is Necessary
Cash-flow analysis shows whether your daily operations have generated enough
cash to meet your obligations, and it shows how major outflows relate to
major inflows. As a result, you can tell if inflows and outflows from your
operation combine to result in a positive cash-flow from operations or in a
net drain. Any significant changes over time will also appear. Understanding
this will lead to better control of cash-flows and will allow adequate time
to plan and prepare for the growth of your business.
It is best to have enough cash
on hand each month to pay the cash obligations of the following month. A
monthly cash-flow projection helps to project funds and compare actual
figures to past months. It is important to project your monthly cash-flow to identify
and eliminate deficiencies or surpluses in cash. When cash-flow deficiencies
are found, business financial plans must be altered to provide more cash.
When excess cash is revealed, it might indicate excessive borrowing or idle
money that could be invested. The objective is to develop a plan which will
provide a well-balanced cash flow.
Planning
a Positive Cash Flow
To achieve a positive cash flow, you must have a sound plan. Cash reserves
can be increased by:
Collection
of receivables Tightened
credit requirements
Price
of products Loans
Increased
sales
Collection
of Receivables
Actively manage accounts receivable and quickly collect overdue accounts.
Revenues are lost when a firm's collection policies are not aggressive. The
longer your customer's balance remains unpaid, the less likely it is that you
will receive full payment.
Tightened
Credit Requirements
As credit and terms are tightened, more customers must pay cash for their
purchases, thereby increasing the cash on hand and reducing the bad debt
expense. While tightening credit is helpful in the short run, it may not be
advantageous in the long run. Looser credit allows more customers the
opportunity to purchase your products or services. But, be certain that the
increase in sales is greater than the increase in bad-debt expenses.
Pricing
of Products
The primary goal of business is to make a profit. Many small businesses fail
to do so because they do not know how to price their products or services.
Pricing is the critical element in achieving a profit as well as in
maintaining positive cash flow, and is a factor all firms can control.
Before setting your prices, you
must understand your product's market, distribution costs, and competition.
Remember, the marketplace responds rapidly to technological advances and
international competition. You must keep abreast of the factors that affect
pricing and be ready to adjust.
Loans
Loans from various financial institutions are often necessary for covering short-term
cash-flow problems. Revolving credit lines and equity loans are common types
of credit used in this situation.
Increased
Sales
Increased sales would appear to increase cash flow, but be careful. For many
companies, a large portion of sales are purchased on credit. Therefore, when
sales increase, accounts receivable increases, not cash. Collection of
receivables is usually 30 days after the purchase date, and sales expenses
are most often incurred before receivables are collected. When sales rise,
inventory is depleted and must be replaced. Because receivables have not yet
been collected, a substantial increase in sales can quickly deplete a firm's
cash reserves. Again, by using a computer, you can maintain this critical
data, as well as speed the time required to consider the "what if"
concept.
Cash
Reserve
You should always keep enough cash, as an added cushion for security, on hand
to cover expenses. But, it is unwise to keep more money on hand than is
necessary to cover your obligations. Excess cash should be invested in an
accessible, interest bearing, low-risk account, such as a savings account,
short-term CD or T-bill. Keeping excess cash on hand reduces both the growth
and the return on investment.
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