Where’s the cash?

START BY reviewing financial statements – the profit and loss and the balance sheet – and look for things like sales growth, profit, asset growth and changes in current assets, current liabilities, inventory levels, equipment and total liabilities. Then have a serious look at the business ratios that measure the drivers of cash flow, including inventory turn days and accounts receivable collection days.

Assess the metrics in relation to other companies like yours or compared with your own best performance in a prior year. A business that underperforms at managing these things, or that shows low liquidity as compared with its peers, should establish goals and action plans to improve cash flow.

Still, answering the question ‘Where is the cash?’ can be a mystery for many statement readers. As the accrual basis of accounting provides the most accurate picture of profitability, most businesses use it to produce their financial statements. Unfortunately, it does not provide a clear picture of cash flow.

The balance sheet also falls short – while it holds the clues, it only shows a snapshot of the bank balance at the end of the period without detailing the movement of cash throughout the period under review.

The statement of sources and application of funds unlocks the clues by measuring cash in and/or cash out through these functional areas of the business: 

• Operating – revenue, expenses, inventory, accounts receivable, accounts payable and short-term financing (like credit lines or credit cards);
• Investing – inventory purchases, facility expansion or other long-term investments;
• and Financing – new borrowing and repaying existing debt.

Every business needs a regular statement of cash flow because it clearly identifies the differences between profit and cash, and shows the impact all business activities have on cash. T

he income statement shows all revenues, expenses and the “bottom line” difference between the two, net profit. Many things other than expenses consume cash, and businesses receive money for things other than revenue.

The sources and application of funds statement will recognise these categories. The statement shows the beginning balance of cash and then details the amount provided by or consumed by operating, investing and financing activities of the business, to arrive at the ending balance of cash.

This is how the statement answers the question ‘Where is the cash?’

A monthly cash budget is constructed by forecasting (estimating) these same things. For most companies, a complete cash budget accounts for predicted inventory purchases, borrowing, debt repayments and distributions to owners because these items are not included in the income statement budget.

In addition, companies carrying significant accounts receivable must account for a lag between the time when revenues are earned and collected (accounts receivable collection assumptions).

With budgets for both profit and cash, you are armed with two powerful tools for planning and control that no business should be without.

To summarise, these disciplines can help you understand and predict your cash flow needs, assuring you’ll have the funds available when you need them.

• Review financial statements and cash flow ratios regularly;
• Prepare a monthly income statement budget that accounts for seasonality to serve as your profit plan;
• Prepare a monthly cash budget that accounts for all cash in and cash out to predict your borrowing needs and possible cash shortages; and
• Use the cash budget and profit plan to negotiate for financing well in advance of the time you’ll need the funds.

Tips for improving your cash flow

• Review financial statements each month, including the statement of cash flow, to gain an intuitive sense of how decisions and business conditions impact both profit and cash;
• Prepare a cash budget for the coming year to predict possible cash shortages. Use it to determine the minimum line of credit that you will need to negotiate with your lender;
• Budget for inventory and other equipment purchases. These do not appear on your profit and loss statement and are typically not part of a budget for revenue and expenses. Plan in advance to finance purchases of long-term assets so you retain cash. The best time to ask for money is before you need it;
• Use your credit line for working capital. If you are routinely at the top of your limit discuss refinancing options with your lender;
• Monitor trade supplier balances and maintain accounts within their terms;
• Minimise your cost of carrying receivables by taking credit cards in lieu of offering in-house accounts to customers;
  • Make it easy for customers to pay by offering a range of payment options.
  • Be clear about who you grant credit to and what terms you offer.
  • Make use of credit checks and establish a service history before you grant credit.
  • Issue invoices regularly instead of waiting until statements go out at month end.
  • Know what it takes to get a bill paid and who to call if there is a problem.
  • Establish a routine for follow up of past due accounts and stick to it
• Control your investment in retail inventory to reduce the amount of cash tied up;
• Review your retail inventory holdings and target old inventory for quick sale;
• Review sales and inventory levels regularly. Schedule ordering to coincide with demand to avoid tying up cash in merchandise;
• Make sure inventory control and buying practices are communicated, understood and followed by staff. Consider how to improve procedures to improve inventory efficiency; and
• Establish a calendar for expanding your business. Detail milestones for adding equipment lines, staff or locations. Estimate the funds needed and investigate financing options well in advance of the targeted expansion.

Stuart Donaldson business educator