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Basics of Cash Management: For Financial Management and Reporting
Basics of Cash Management: For Financial Management and Reporting
E-mail: soaga_hameed@yahoo.com
Abstract
This paper examines the basics of cash management for financial
management and financial reporting purposes. This study makes use of
descriptive research method to examine the importance, essence, influence,
relationship, and impact of cash management on financial management
and financial reporting. It establishes the strong impact of cash
management on corporate survival, linkage to practically every account on
financial report, maximisation of shareholders’ wealth, fraud prevention and
detection, and liquidity enrichment. It also ascertains the need for the use of
net cash flows as a measure of performance. Organisations should give cash
management serious attention and make it a strategic partner, and should
maintain a dedicated cash module for cash management because accrual
accounting is not adequate for cash management. Regulatory bodies should
enhance disclosure requirements in respect of cash and cash equivalents to
enhance transparency and prevent creative cash management.
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Basics of Cash Management for Financial Management & Reporting
1 Introduction
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Basics of Cash Management for Financial Management & Reporting
nine discusses foreign currency cash management; and lastly, section ten is
the conclusion and recommendations.
Personnel cost
Sundry Revenue
(Financing, Investing)
Cash
Capital expenditure
Office/Overhead
expenses
Statutory expenses
(i.e. tax)
Other outflows
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Basics of Cash Management for Financial Management & Reporting
In the ancient time, peeping into the future by specialised warlords was a
lucrative business and imperative for empires and ventures. Soothsayers made
fortune from forecasting: Joseph/Yusuf, in holy books, became stupendously
wealthy and a head-of-state because of his interpretation of dreams (data). In
today’s information age, forecasting is an important tool for planning and
decision-making to attain corporate success. Successful finance chiefs are
great forecasters. Forecast is an essential financial management tool, it
discloses Strengths, Weaknesses, Opportunities, and Threats (SWOT) that
forestall solvency, utilises opportunities, engender profitability, among others.
Forecast should be prepared regularly to reflect the destination of the entity on
forth night basis and monthly, aside the beginning of the year forecast. Cash
forecast allows the identification of gaps in finance before liquidity and
solvency disasters struck the going concern foundation. Strength of cash
forecast and subsequently cash budget is in the management projection
dexterity. Cash forecast depends heavily on historical information and
judgemental rulings base on business experience. Cash management practice
demands that management should avoid human reaction to historical
experience that could lead to imprecision. Forecast can be esoteric because it
goes very deep and require insights beyond even Monte Carlo; it can be
exceedingly judgemental as nature of business demands. Forecast should be
organisation-based, consider past forecasting errors, and important trends in
the external environment like economy, law, politics inflation. Seasonal
variations that are usual and the ones that are foreseen should be considered in
cash flows forecast. Sales forecast is the most important item in the
preparation of cash forecast and budget; normally, cash inflow from sales is
the premier and other forecasts are dependent on it. To enhance the accuracy
of sales forecast, internal and external environmental factors should be
considered.
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Basics of Cash Management for Financial Management & Reporting
There is a thin line between cash forecast and cash budgets that many
cannot distinguish one from the other. This is because the procedures for
preparing the two are the same. Cash budget like every other forms of budget
relates to short-term financial expression of an organisation’s corporate
objectives for the entity’s fiscal period, usually one year. In terms of
periodicity, cash budget like every other type of budget can be enhanced if
flexed to reflect business realities from time to time. Thirteen-week budget is
a regular form of cash budget. Due to the volatility of cash, there is need for
regular review of cash budget; fortnight or monthly budget is proactive for
effective cash management. On the other hand, Cash forecast is projection
tool of business reality.
Cash position is a critical report that the finance chief should spend the
first part of the day on before any payment. It is the nucleus of cash
management system. Besides, it is a control mechanism that ensures
arithmetical and accounting accuracy (of postings), it assists in the detection
and correction of errors such as casting, commission, omission. Cash position
is for internal reporting purpose; it is a good memorandum record and
explains daily cash movement. Arithmetically, the report is opening balance
(previous period closing balance) plus cash inflows (from customers/clients,
reversal/cancellation of previous payments like stale cheques, cash/cheque
exchange, investments, fixed/time deposits, transfers) minus cash outflows (to
payables such as creditors, governments (taxes, levies), payroll, shareholders,
intergroup) minus provisions for contingencies. For the purpose of brevity,
cash position report should be a page and should be categorised. Cash position
can be categorised base on the nature of payments, as well as receipts, of an
organisation. A model daily cash position report is easy and time saving to
prepare. To ensure good practice, it is advisable that previous day report be
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Basics of Cash Management for Financial Management & Reporting
ready before any disbursement. Quality financial reporting system will have
the cash position reconcilable to ledger balances.
Once an enterprise does not operate cash only policy there are bound to
be account receivables. Therefore, customers/clients should be appropriately
prequalified to weed out ones with high default risk and reliable invoice
should be sent timely. Late payment of outstanding and bad debt is big
problem on cash management; they can result in cash flow problems that can
cripple organization of any size. Credit control can be a simple task where
there is stringent and keenly monitored credit management policy.
Conversely, delinquent debtors are ingenious with the truth when payment is
demanded. They come up with any of the various excuses such as the cheque
is in the post, the document to process payment is just being signed now, or
request for invoice to be resent? When credit control is getting to this level,
outsourcing could be the solution to improve cash flows, reduce debtor days
and potential bad debt, or management needs a very tactful credit
management.
payment capacity that would often result to bad debt, to achieve their
performance. Sales commission plan should be drawn to give the enterprise
the best compensation; it should be at the best interest of the company and
should be aligned to corporate objectives. For instance, sales commission
could be structured such that commission would only be paid when customer
pays, to motivate collections, but should avoid sales taking up credit control
tasks rather than sales. Judicious use of Bad Debt Reserves to Receivables
ratio assists in improving cash flows and earning through strategic credit
management. Finally, the ultimate tool for credit control and management is
relationship. In a business experience, a credit control officer achieved what
other approaches, including restlessness and litigation, could not through
relationship. The best credit control officer is a relationship professional.
many hushed reasons like incorrect beginning balance (i.e. item(s) not
considered in earlier reconciliation on cashbook, system error), errors (i.e.
transposition, addition, subtraction, commission, error on cheque register etc),
incorrect bank beginning balance (i.e. bank charges that hit statement after
dispatch of statement), and many others. These problems are preventable by
setting-up appropriate reconciliation and information management processes,
improving organization, training, and automation.
The common and known form of cash flows analysis is on cash flows
ratios, with nominators and denominators from audited, and assured financial
statements – cash flows statements, balance sheet and profit and loss
accounts. For financial management purposes, management cash flows
analysis is more detailed and customised to the nature of an organisation
operation. Unlike cash flows statement, that is uniform irrespective of
organisation under direct and indirect methods, cash flows analysis of a
trading company is clearly dissimilar from that of a manufacturing. In fact,
within trading enterprises, as an example, management cash flows analysis
report could be very distinct because of financial management strategy, which
is drawn from corporate objectives, dictates the drivers. Management cash
flows analysis reveals the actual situation in details and tremendously assists
management in forecasting, planning, and control. Management cash flows
analysis is different from cash budget and cash forecast, it is a stewardship
report in details for both inflows and outflows
The operating cash flows ratio is one of the most important cash flows
ratios. Cash flows are an indication of how cash move into and out of an
enterprise. Operating cash flows connotes cash flows that an entity accrues
from operations to its current debt. Operating cash flows measures how liquid
an entity is in the short run by relating cash flows from operations to current
liabilities. The operating cash flows ratio (OCF) measures a company's ability
to generate the resources required to meet its current liabilities. The equation
is:
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Cash current debt coverage (CCD) is a ratio that can be used to measure
a company's ability to pay back its current debt. Cash Current Debt coverage
is calculated as follows:
Cash current debt coverage (CCD) = (Cash flow from operations – cash
dividends) /Current interest-bearing debt
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Basics of Cash Management for Financial Management & Reporting
This ratio compares company’s market value to its operating cash flow.
The company market capitalization is divided by operating cash flow. This
could be carried out on unit basis by using market price per share as
nominator, while operating cash per share (Operating cash flow/Number of
shares) as denominator. Some analyst use free cash flows in the denominator
in place of operating cash flow. The closing price of the stock on a particular
day is usually share price. A lower price/cash flow ratio connotes a better
value stock, everything being equal. Calculation of price/cash flow ratio is as
follows:
It compares the company's share price to the cash flow the company
generates on a per share basis. It is a valuable ratio for a company that is
publicly traded. Because of the realism of cash, the price to cash flow ratio is
often considered a better measure of a company's value than the price to
earnings ratio, most analysts use price/earnings ratio in valuation analysis.
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Basics of Cash Management for Financial Management & Reporting
This is popular with the name burn rate or runaway rate. It shows how a
firm can efficiently transform sales to cash. The Cash Flows Margin ratio is
an important ratio as it expresses the relationship between cash generated
from operations and sales. Every enterprise needs cash to discharge
obligations to owners, creditors, government, and invest on capital assets and
expansion. The calculation is:
Cash Flows Margin Ratio = Cash flows from operating cash flows / Net
sales
The numerator of the equation comes from the firm's Statement of Cash
Flows. The denominator comes from the Income Statement. Larger
percentage indicates better ability of the firm to translate sales into cash. A
pattern of receivables that rise significantly faster than sales may be indicative
of aggressive revenue recognition. It might also reveal the implementation of
lower credit standards as a ploy to capture less creditworthy customers to
creatively boast earnings.
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Basics of Cash Management for Financial Management & Reporting
Cash flows from operations is taken from the Statement of Cash Flows
and average total liabilities is an average of total liabilities from several time
periods of liabilities taken from balance sheets. The higher the ratio, the better
the firm is financially flexible and able to discharge its obligation to creditors.
The net income to operating cash flows ratio is a very important cash
ratio; it reveals how much an enterprise is able to generate cash from earnings
and the long run sustainability of the firm. This ratio allows for comparing
earnings to cash flows, increasing earnings and decreasing cash flows is an
indication of decrease in earnings in the future. The occurrence of increasing
earnings combined with decreasing cash flows imply accounting shenanigans,
or cash management problems such as cash conversion cycle problem, poor
credit control and management; accounts receivables could increase because
customers do not have the cash to pay. An unforeseen sales slowdown could
push inventory levels up. However, these events can also foretell an earnings
slowdown. The calculation of the ratio is as below:
The numerator of this fraction is change in the earnings per Share (EPS),
represents a enterprise’s after tax profit divided by the number of shares. The
denominator is the change in operating cash flows, which is found right on the
cash flows statement, represents in a company's accounting earnings adjusted
for non-cash items and changes in working capital. Earnings management can
be detected with the use of net income to operating cash flows ratio
If the ratio falls below 1.00, then the company is not generating enough
cash to justify its performance. In this case, the company is either creative in
reporting or the cash management needs overhauling. The ratio is not
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Basics of Cash Management for Financial Management & Reporting
exclusive; it can be compared with other firms and the trend analysis is a fine
tool. It is critical that cash flow from operations not lag behind net income for
an extended period of time. Whenever a company is not collecting the cash
related to its reported earnings, then it calls into question the quality of those
earnings. If net income to operating cash flows ratio was employed; big
corporate failures like W. T. Grant, Chrysler would have been averted.
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Basics of Cash Management for Financial Management & Reporting
Operating cash flows to total asset ratio is useful for internal assessment
and to compare the company to other firms in the industry. The numerator is
right on cash flows statement, while the denominator is on the face of balance
sheet. It shows the destination of the company. The formular for this ratio is
as below:
The higher the ratio, the more cash that is available for retaining for
growth. Enterprises should strive to improve operating cash flows to total
assets ratio for the sustainability of the organisation. .
transactions, are better done through bank. Good finance practice is to release
confirmed cheque so that cheques get cleared on time to allow beneficiaries
access to fund. Not releasing cheques timely can cost the organisation
tremendously in the end; organisation can be deprived of the imperative
service/good thereby telling drastically on operations, loss of reputation,
which can lead to payments in cash or draft. Additional costs such as
commission, lead-time, interest on bank draft, transport cost, security hazard
of carrying cash.
scheme to strip people about $17 billion to satisfy his veracious craving for
cash, Tyco International used creative accounting to divert company’s fund to
its CEO and CFO
One major challenge about cash flows statement is that auditors do not
carry out detail examination as done for revenue and balance sheet accounts.
There are many intricacies behind every amount on the face of cash flows
statement. This gives the preparers of financial statements opportunity to take
advantage of this lapse. An enterprise could utilise factoring to drive up cash
balance on the financial statements. It is noteworthy that poor cash flows
while the two other financial statements composites are good is a signal that
there is a smoke.
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Basics of Cash Management for Financial Management & Reporting
The fact that cash is king should not intoxicate treasury. It is a smart
decision to intimate creditors of the organisation’s liquidity condition and
reach a favourable date for payment to preserve creditors’ confidence in the
enterprise. Getting creditors acquainted on time enhances their willingness to
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Basics of Cash Management for Financial Management & Reporting
One major problem with the current global capitalism is the wrong
impression that earnings are the acme of organization success. This
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Basics of Cash Management for Financial Management & Reporting
Foreign exchange rate fluctuation can push a bottom line from profit
unto loss. Contrary to the believe by some finance folks that exchange
difference is an ordinary paper profit/loss, the risk of foreign exchange is
basically on profit and it is real. The main issue on foreign currency
management is hedging of exposure to adverse foreign exchange difference
and encouragement of currency speculation for profit. Generally, foreign
exchange risk hedging is either forward contract or option rate. To reduce
inherent foreign exchange risk conversion, enterprise can hedge the risk by
forward contracts, fixed forward or floating/option contracts; invoicing
foreign clients/customers in local currency; and matching income against
expense/expenditure in the domiciliary bank account. Other strategies are
protection clause on sale price in foreign currency or adjusted exchange rate
moves outside a defined range; invoicing in a strong currency; and pricing
policy, by building extra profit margin into selling price to act as a cushion in
the event that exchange rates move adversely.
should tread the path of prudency and disclosures of foreign currency impacts
(particularly on earnings) to minimise creativity.
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BIBLIOGRAPHY
Hope, J., 2006, Use a Rolling Forecast to Spot Trends, an excerpt from
Reinventing the CFO: How Financial Managers Can Transform their Roles
and Add Greater Value, Harvard Business School Press, USA.
Jensen, M. C., 1986, "Agency costs of free cash flow, corporate finance,
and takeovers.” American Economic Review 76 (2): 323–329.
doi:10.2139/ssrn.99580.
Winning Investing, 2002, Spot Accounting Red Flags the Easy Way Use
cash flow to detect creative accounting, Winning Investing • 411 Palmer
Avenue • Aptos, CA 95003, published 12/15/02,
http://www.dividenddetective.com/, www.winninginvesting.com
Weiss, P., 2000, Calculating Cash Flow Ratios, The Motley Fool,
www.fool.com, July 07, 2000.
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