By Ben Heunes, Head: Regenesys Centre for Finance
Why is it that big companies with high turnover seldom have enough cash to pay the bills?
This is often a result of a “cash flow problem”. This means that cash flowing into the business is out of synch with the cash moving out. The result is that the business is temporarily caught short when the bills are due. Planning and forecasting will determine whether a company will have enough cash available when it is required.
WHAT IS CASH?
Cash is money in the bank or in the business. It is not inventory, accounts receivable or fixed assets. These can be converted to cash at some point in time, but it takes cash on hand to pay overheads, other expenses and to meet the payroll. Profit growth does not necessarily mean more cash. There is a vast difference between the two.
Profit is the amount of money you expect to make if all customers paid on time and if your expenses were spread out evenly over a period of time. Although this is the ideal situation, it is not your day-to-day reality.
Cash is what you must have to keep the doors of your business open, while you are busy trying to make a profit. Over time, a company’s profits are of little value if they are not accompanied by positive net cash flow.
You can’t spend profit; you can only spend cash.
WHAT IS CASH FLOW?
Cash flow simply refers to the flow of cash into and out of a business. Managing the cash inflow and outflow is one of the most important tasks of the financial management team. The outflow of cash is measured by expenditures and overheads such as salaries, suppliers, and creditors. The inflows could include the cash you receive from customers, lenders, and investors.
Positive Cash Flow
If the cash coming “in” to the business is more than the cash going “out” of the business, the company has a positive cash flow. A positive cash flow is what every company hopes for. The only concern is how to invest or spend the excess cash. Like good health, a positive cash flow is something you’re most aware of if you don’t have it.
Negative Cash Flow
If the cash going “out” of the business is more than the cash coming “in” to the business, the company has a negative cash flow. A negative cash flow can be caused by a number of reasons. For example: too much or obsolete inventory or poor collections on the accounts receivable.
What are the components of cash flow?
A Cash Flow Statement is typically divided into three components so that you can see and understand the sources and uses of cash. These components include internal and external sources:
- Operating cash Flow (Internal)
- Investing cash Flow (Internal)
- Financing cash Flow (External)
Operating Cash Flow
Operating cash flow, often referred to as working capital, is the cash flow generated from internal operations. It is the cash generated from sales of the product or service of your business. It is the real lifeblood of your business, and because it is generated internally, it is within your control.
Investing Cash Flow
Investing cash flow is generated internally from non-operating activities. This component would include investments in plant and equipment or other fixed assets, nonrecurring gains or losses, or other sources and uses of cash outside of normal operations.
Financing Cash Flow
Financing cash flow is the cash to and from external sources, such as lenders, investors and shareholders. A new loan, the repayment of a loan, the issuance of stock and the payment of dividend are some of the activities that would be included in this section of the cash flow statement.
HOW DO I PRACTICE GOOD CASH MANAGEMENT?
Cash management is simple. It means:
- Predicting when and where your cash needs will arise
- Knowing what the best sources are for meeting additional cash requirements; and,
- Being prepared to meet these needs when they occur, by keeping good relationships with bankers and other creditors.
The starting point for avoiding a cash crisis is to develop a cash flow projection. Smart business owners know how to develop both short-term (weekly, monthly) cash flow projections to help them manage daily cash, and long-term (annual, 3-5 year) cash flow projections to help them develop the necessary capital strategy to meet their business needs.
