Cash Flow: It’s Dynamic, Not Static

From the time a cash flow report is produced until it is reviewed, it is inaccurate.  It may be accurate enough for decision making when it is produced but it ages quickly.  Each business day (or hour) changes the numbers on the report and consequently your cash flow position.  Effective management of cash flow will directly impact the working capital that your business needs to conduct business and to successfully work with unexpected business conditions.

To deal with this dynamic report condition, it is important to understand what impacts your cash flow position.  This means that you not only have to know what transactions impact your cash flow but also the timing of those transactions and the business processes from day-to-day, week-to-week and month-to-month.

Balancing Cash FlowCF Chart
Cash flow is affected by disbursements (cash out) of cash for paychecks, materials, rent, loan payments, taxes, etc. and by receipts (cash in) of cash from customers, interest, customer prepayments, etc. Each of these cash events occurs at different times and in varying amounts, so the balance of inflows (cash in) and outflows (cash out) do not consistently balance each other.  In total, for a given period, inflows may exceed outflows. The result is dependent on the timing, if your bank account is low and outflows exceed inflows, you may not have enough cash to cover your cash out requirements.

Consider two examples:
Example 1 – A company with a beginning cash position (blue line) of $50,000 on day 1 faces two payrolls of $30,000 on day 14 and 28, scheduled payments to vendors every 7 days that average $20,000 per cycle, and expected receivables of $35,000 every 7 seven days.CF Ex1
Example 2 – Using the same company with payables paid in a nonlinear stream resulting in $40,000 on day 7, $40,000 on day 14 and $20,000 on day 21.  Receivables on the other hand arrive throughout the month in a different pattern where $10,000 arrives on day 7, $20,000 on day 14, $45,000 on day 21 and $85,000 on day 28. The cash balance (blue line) in this example goes negative on day 14 even though the cash in and out for the 28 day period are the same but the timing in which they occur is significantly different.CF Ex2
In the first example, the outflows (payroll and payables) were balanced with inflows (receivables).  In the second example, we see the same amounts of outflows and inflows over the same 28-day period but due to the impact of outflows exceeding inflow early in the month the cash position goes negative for 14 days but with the large receivable arriving on the last day cash does return to the $50,000 position on day 28.
In the first example, the outflows (payroll and payables) were balanced with inflows (receivables).
The dynamics of example 2 are significantly different from that of example 1. Different cash flow strategies are required in example 2 to manage and change the demands on cash result in a consistently positive balance so that the business can meet its obligations.

Can this happen in a business where there are managers and business processes? The answer is – Yes!

The orchestration of balancing cash flows is something that must be constantly managed and monitored.  The operations that commit the company to financial obligations need to clear the timing of the payment of those obligations with the senior financial officer who should also review them with the senior manager – owner, CEO, or GM.  Meeting unexpected cash obligations can trigger a tight cash flow condition that could adversely impact the free cash and working capital of the business until extra cash is accrued from regular business operations or by an infusion of cash from a line of credit.

Crisis: Line of Credit
Businesses that do not commit to a strong cash flow discipline are subject to “cash crisis’s” where a line of credit may need to be used which, of course, increases the cost of money used to cover the short fall.  It is a good practice to setup a line of credit even when you do not need it or expect to use it.  The unexpected may happen.  If used, however, there should be a concentrated effort to pay down the line.

Companies that make a regular practice of living off of their line of credit have not committed to cash flow planning or have business practices that are not consistent with running a business properly. Consequently cash is tied up unnecessarily reducing the flexibility of the business to respond to changing business conditions.

Cash Flow Calendar
A good business practice is to use a cash flow calendar, which identifies when major cash transactions will occur (i.e. pay day, when scheduled payables are paid, tax payments, extra payroll, etc.).  This practice requires monitoring, at regular intervals, the primary bank account that receives receipts on schedule and can make scheduled payments for the business.

Cash Flow Strategy
It is not unusual for a company to adopt a short-term strategy when extraordinary conditions arise, such as, a major account holding their payment for a significant portion of their receivables.  This would cause a major hit to cash in and something would need to be done to compensate for the loss in receivables until the interruption of the payment is resolved.

A possible strategy might include using a line of credit, slowing down payments to vendors, reducing purchases and or expediting payments from customers (making sure they pay on time).  These measures may be used to cover a short-term weakness in the cash flow capacity of the business but if used for an extended period may affect delivery of products and services from vendors. Ultimately the ability to meet customer requirements may be jeopardized.

Successful business owners say, “Cash is king!” A business cannot run without cash and it takes an intentional effort by management to manage the cash flow of the business responsibly.

In the ‘90’s, dotcom’s were known to operate using a “burn rate” as an indication of their commitment to the business and market they were participating in.  However, once the burn rate consumed the startup investment, many of them folded.  This was an example of irresponsible management of a valuable cash investment.

Those that survived took a different approach and managed their cash very carefully. The same principle applies to all businesses.  Throwing cash around is not the formula to success. Just letting the financial guy worry about cash is also not the formula to success. In high achieving organizations, cash management is a team effort.

Take the initiative and manage the dynamic elements of your cash flow system.  Know what its sensitivity is to various factors and develop strategies to make sure that those sensitivities do not put the business at risk.

Manage your dynamic cash flow system responsibly.


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