Cash Flow can be considered a barometer of the financial health of any business. An effective cash flow policy includes planning and management. In a perfect world, your monthly revenues cover your monthly expenses and leave a surplus, i.e. a profit that increases cash reserves. But the perfect world is a theoretical place.
In reality, businesses have cycles. Retailers that survive lean months are able to benefit from the peak shopping season that occurs from the end of November through the early part of January. Drug companies invest large sums of money today in research and development, to offer a medicine in the future for a finite time period, prior to patent expiration. These are examples of industries that excel at the planning and management of cash flow.
But the benefits of proper cash flow management or the penalties of poor planning can affect companies of all sizes. Drains on a company’s cash flow fall into two categories –
- Controllable – expenses where management has a potential impact, which include – salaries, rent, advertising and marketing, travel & entertainment expenses. This impact can be defined as controlling the amount of the expense or the timing of the expense.
- Uncontrollable – expenses where management has little or no ability to impact, which include delayed payments from individuals or companies where you extended credit i.e. customers 60, 90, 120 days past due.
Poor cash flow management will impact a business by constraining its ability to fill orders timely if inputs and/or inventory purchases are delayed; replacing outdated equipment; and, implementing process improvement which historically has upfront costs, prior to the savings. As a result of these issues, a business may be forced to seek financing from a lender; and/or, seek outside investors. If unsuccessful at these activities, the business may need to close its doors or sell to a competitor.
In my experience, the best way to avoid these business constraining impacts is to ensure an annual budget is established. Subsequently, monitor actual results to understand if these results are in line with your expectations. Monitoring should occur monthly with the results reviewed with senior management. If needed, expectations should be adjusted to account for any unanticipated business change.
Even after all the planning, it is prudent to maintain a cash reserve cushion. The proper size of this cushion is dependent on the business.
What is your experience?© Copyright 2012 Regis Quirin, All rights Reserved. Written For: CFO Tips - What you need to know, to be a CFO TODAY!