Cash Flow Planning and Profits

Cash Flow Planning is something that many companies do not integrate with the normal budgeting and profit forecast process. For some companies this is not a serious problem in a “normal” economy as they have sufficient cash reserves or credit line that can absorb the normal ebbs and flows of cash demands of the company. In todays economy where cash reserves have been depleted or credit lines tightened or “lost” raises a new demand for “accurate” cash flow planning.

If I make a profit then whats the big deal about cash flow? Profits on most company financials do not represent cash but a sale that is a liability on the customer to pay at some time in the future. Until the customer pays the company uses working capital to pay for inventory, employee wages, heat, lights and other expenses. It is the management of customer payments and company obligations that results in either positive or negative cash flow.

Isn’t it just a matter of making sure receivables are greater than payables – right? This would be a simplistic view of managing cash flow as this attitude would most likely not recognize factors that influence the changes in Days Sales Outstanding (DSO) or balancing non-uniform demands for cash such as new products, tax payments. capital expenditures or debt reduction.

DSO is a measure of the number of days that a company takes to collect revenue after a sale has been made. Why would DSO vary?

  1. Products that have quality issues and do not operate properly will cause payments to be delayed until the products perform.
  2. The customer mix changes where the majority of customers paying in 45 days days may transition to customers who push payments out to 60 days – or more.
  3. Customer cash flow problems can filter down to you where they may delay payments to improve their own cash flow situation.

So if I do a good job on collections cash flow can be managed? Managing the inflow of cash is important but it is also critical that you look what expense and asset strategies you are using in the company. Such as:

  1. Carrying inventory that is not being used consumes cash making it unavailable for other purposes such as paying wages, lease payments, etc. Excess inventory can even result in lost cash if the inventory becomes absolute and is written off – thrown away.
  2. Capital expenditures such as equipment or buildings consume cash prior to getting a return on the investment. Timing of investing in capital expenditures can put positive cash flow at risk.
  3. Factory cost or the cost of goods sold – labor and material – will put pressure on cash if productivity and quality objectives are not kept to insure that a dollar of sales will yield a predictable gross margin. Loss of control in labor cost, productivity, quality or material cost can create products that cost more than expected and/ or delivered later that expected resulting in a cash flow crisis.
  4. Vendor financial stability can become a problem where they may need to tighten their collection policies which may require you to pay early if there are not otters sources for the same product or service that will let you pay on the same schedule you have planned into your cash flow plan.

Good cash flow management is not an accident. Intentional action is required on a regular basis to make sure that all of the factors that support your cash flow plan are in order. Cash is king – but you have to take a proactive role with your organization to make sure you achieve your cash flow objectives. Integrated cash flow planning is essential. Developing cash models of your business will help you and your team understand the sensitivity of your specific business model to factors that can cripple or impede good cash flow management.

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