Cash Flow 13

Section 3:
Launching the Business
Copyright © 2019, 2016, 2014 Pearson Education Ltd. All Rights Reserved
Essentials of Entrepreneurship and Small
Business Management
Ninth Edition, Global Edition
Chapter 13
Managing Cash Flow
Copyright © 2019, 2016, 2014 Pearson Education Ltd. All Rights Reserved.
Learning Objectives (1 of 2)
1. Explain the importance of cash management to a small
company’s success.
2. Differentiate between cash and profits.
3. Describe the five steps in creating a cash budget.
Learning Objectives (2 of 2)
4. Describe fundamental principles involved in managing
the “big three” of cash management: accounts
receivable, accounts payable, and inventory.
5. Explain the techniques for avoiding a cash crunch in a
small company.
The Importance of Cash
• “Everything is about cash – raising it, conserving it,
collecting it.” ~ Guy Kawasaki
• Common cause of business failure: Cash crisis!
• It is possible for a business to earn a profit and still go out
of business by running out of cash.
– Valley of death
The Valley of Death
Figure 13.1 The Valley of Death
Source: Based on Yoshitaka Osawa and Kumiko Miyazaki, “An Empirical Analysis of the Valley of
Death: Large Scale R&D Project Performance in a Japanese Diversified Company,” Asian Journal of
Technology Innovation, vol. 14, no. 2, 2006, pp. 93–116.
Cash Management (1 of 2)
• Wasp Barcode survey:
– 42% of the owners of small businesses with 50 or
fewer employees say that managing cash flow is the
top business problem they face
• Startup Founder Data survey:
– 75% of start-up founders report cash flow concerns as
their top challenge
Small Business Owner’s Rating of their
Companies’ Cash Flow
Figure 13.2 Small Business Owners’ Ratings of Their
Companies’ Cash Flow
Source: Based on data from Wells Fargo Small Business Index, 3rd Quarter, 2017, pp. 12–13.
Cash Management (2 of 2)
• Cash management:
– The process of forecasting, collecting, disbursing,
investing, and planning for the cash a company needs
to operate smoothly.
• Young and growing companies are “cash sponges.”
• Know your company’s cash flow cycle.
Signs of an Impending Cash Flow Crisis (1 of 2)
• Excess supplies of inventory
• Large stock of “old” inventory items that never sold
• Significant volume of fixed asset purchases, such as
machinery and equipment
• Accounts receivable that are past due and growing
• Failing to take advantage of cash discounts from vendors
and suppliers
• Late payments to vendors and suppliers
• Missed quarterly tax payments
• Past-due loan payments
Signs of an Impending Cash Flow Crisis (2 of 2)
• Above-average interest expense because of excessive business
debt
• Average collection period ratio above the industry median
• Missed sales because popular inventory items are out of stock
• Difficulty meeting payroll on time
• Rapid increase in business expenses
• Rapid increase in accounts receivable balance
• Minimal or no financial controls in place to monitor potential theft
• Infrequent preparation and use of financial statements as a
managerial tool
• Failure to develop cash flow forecasts
Cash Flow Cycle (1 of 2)
• Cash flow cycle:
– the time lag between paying suppliers for merchandise
or materials and receiving payment from customers
Cash Flow Cycle (2 of 2)
Figure 13.3 The Cash Flow Cycle
Cash and Profits
• Cash ≠ profits.
• Profit is the difference between a company’s total revenue
and total expenses.
• Cash is the money that is free and readily available to use.
• Cash flow measures a company’s liquidity and its ability to
pay it bills.
The Cash Budget
• Cash budget:
– A “cash map” that shows the amount and the timing of
a firm's cash receipts and cash disbursements over
time.
• Predicts the amount of cash a company will need to
operate smoothly.
• Helps to visualize a company’s cash receipts and cash
disbursements and the resulting cash balance.
Cash Flow
Figure 13.5 Cash Flow
Preparing a Cash Budget
Five steps:
1. Determining an adequate minimum balance.
2. Forecasting sales.
3. Forecasting cash receipts.
4. Forecasting cash disbursements.
5. Estimating the end-of-the-month cash balance.
Determine an Adequate Minimum Cash
Balance
• Step 1
– The most reliable method of deciding the right
minimum cash balance is based on past experience.
Forecast Sales (1 of 2)
• Step 2
– The heart of the cash budget.
– Sales are ultimately transformed into cash receipts and
cash disbursements.
– Cash forecast is only as accurate as the sales forecast
from which it is derived.
Forecast Sales (2 of 2)
• “Lumpy” or seasonal sales patterns are common.
– 15% to 18% of wine and spirits shops’ annual sales
occur between December 15 and 31.
– 40% of toy sales take place in last 6 weeks of the year.
• Prepare three sales forecasts:
– Pessimistic
– Optimistic
– Most Likely
Sales Forecast for a Start-Up
Example:
Number of cars in trading zone 84,000 autos
× Percent of imports × 24 %
= Number of imported cars in trading zone 20,160 imports
Number of imports in trading zone 20,160 imports
× Average expenditure on repairs and maintenance × $485
= Total import repair sales potential $9,777,600
Total import repair sales potential $9,777,600
× Estimated share of the market × 9.9%
= Sales estimate $967,982
Forecast Cash Receipts
• Step 3
– Record all cash receipts when the cash is actually
received (i.e. the cash method of accounting).
– Determine the collection pattern for credit sales; then
add cash sales.
– Monitor closely: Slow and non-payers.
Probability of Collecting Accounts
Receivable
Figure 13.6 Probability of Collecting Accounts Receivable
Source: Based on data from the Commercial Agency Section, Commercial Law League of America, 2011.
Forecast Cash Disbursements
• Step 4
– Record disbursements when you expect to make them.
– Start with those disbursements that are fixed amounts
due on certain dates.
– Review the business checkbook to ensure accurate
estimates.
– Add a cushion to the estimate to account for “Murphy’s
Law.”
– Don’t know where to begin? Try making a daily list of
the items that generate cash and those that consume it.
Estimate End-of-Month Balance
• Step 5
– Take Beginning Cash Balance ...
– Add Cash Receipts ...
– Subtract Cash Disbursements
– Result Is Cash Surplus or Cash Shortage (Repay or
Borrow?)
Benefits of Cash Management (1 of 2)
• Increase amount and speed of cash flowing into the
company
• Reduce the amount and speed of cash flowing out
• Make the most efficient use of available cash
• Take advantage of money-saving opportunities such as
cash discounts
Benefits of Cash Management (2 of 2)
• Finance seasonal business needs
• Develop a sound borrowing and repayment program
• Impress lenders and investors
• Provide funds for expansion
• Plan for investing surplus cash
The “Big Three” of Cash Management
• Big Three:
1. Accounts receivable
2. Accounts payable
3. Inventory
• The Big Three interact to create a company’s cash
conversion cycle:
– The length of time required to convert inventory and
accounts payable into sales and accounts receivable
and finally back into cash.
Cash Conversion Cycle
Figure 13.7 Cash Conversion Cycle for the Typical Small
Business
Source: Based on data from “2016 Annual Working Capital Opportunity—Corporation Size,” PwC, 2016,
www.pwc.com/gx/en/services/advisory/deals/business-recoveryrestructuring/working-capitalopportunity/size.html.
Accounts Receivable
• About 90% of industrial and wholesale sales are on credit,
and 40% of retail sales are on account.
• Dun & Bradstreet: only 13% of large U.S. companies pay
invoices by the due date.
• Remember: “A sale is not a sale until you collect the
money.”
• Accounts receivable goal: Collect your company’s cash as
fast as you can.
Establish a Credit and Collection Policy
• Screen credit customers carefully.
• Establish a firm credit-granting policy.
• Send invoices promptly.
– Cycle billing
• When an account becomes overdue, take action
immediately.
Accelerating Accounts Receivable
• Ensure that invoices are accurate and timely.
• Include a description of the goods or services purchased.
• Ensure that invoices match purchase orders or contracts.
• Highlight the balance dues and due date.
• Include contact information in case customers have
questions.
• Use a security agreement.
Accounts Payable
• Stretch out payment times as long as possible without
damaging your credit rating.
• Verify all invoices before paying them.
• Negotiate the best possible terms with your suppliers.
• Be honest with creditors; avoid the “the check is in the
mail” syndrome.
• Schedule controllable cash disbursements to come due at
different times.
Accounts Payable Patterns
Figure 13.8 Accounts Payable Pattern Among Businesses
by Size of Company
Source: Based on data from Payment Study 2016, Dun & Bradstreet, 2016, p. 44.
Inventory
• Monitor inventory closely; it can drain a company’s cash.
• Avoid inventory “overbuying.”
– It ties up valuable cash at a zero rate of return.
• Arrange for inventory deliveries at the latest possible date.
• Take advantage of discounts:
– Quantity discounts
– Cash discounts
A Cash Discount
Figure 13.10 A Cash Discount
Cost of Forgoing Cash Discounts
Table 13.8 Cost of Forgoing Cash Discounts
Cash Discount Terms Cost of Forgoing the Cash
Discount (Annually)
2/10, net 30 37.25%
2/10, net 40 24.83%
3/10, net 30 56.44%
3/10, net 40 37.63%
Avoiding the Cash Crunch (1 of 4)
• Barter
– Consider bartering, exchanging goods and services for
other goods and services, to conserve cash.
 More than 500 barter exchanges operate across the
United States.
• Trim overhead costs:
– Ask for discounts and “freebies”
– Conduct periodic expense audits
– Lease rather than buy
 Operating lease
 Capital lease
– Avoid nonessential cash outlays
– Buy used or reconditioned equipment
– Hire part-time employees and freelancers
• Outsource
• Use e-mail rather than mail
• Use credit cards for small purchases
• Negotiate fixed loan payments to coincide with your
company’s cash flow
• Establish an internal security and control system
• Develop a system to battle check fraud
• Change shipping terms
• Start selling gift cards
• Switch to zero-based budgeting
• Be on the lookout for employee theft
• Keep your business plan current
• Build a cash cushion
• Invest surplus cash
– Money market account
– Zero-balance account
Conclusion
• “Cash is King”
• Cash and profits are not the same.
• Entrepreneurial success means operating a company “lean
and mean.”
– Trim wasteful expenditures.
– Invest surplus funds.
– Plan and manage cash flow.
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Section 3:

Launching the Business

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