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Cash Flow: The Key Business Driver

Cash Flow: The Key Business Driver

Most leaders can quickly grasp the idea of the critical need to have enough cash to oil the wheels of enterprise but then don’t pay enough attention to it in practice, often preferring to concentrate on the more theoretical variances between planned and actual expenditures. Leaders should therefore become far less blasé about this key driver of business success and make sure that cash-flow matters are firmly gripped with both hands and at all times – but perhaps this is easier said than done.

One of the reasons that cash-flow is not top-of-mind for many managers is that there is often nothing to see or report if it is positive (or at least if there is enough of it to cope). In other words, if suppliers, payroll and other general bills are being paid, and no-one is complaining, then leaders can continue to concentrate on simply managing day-to-day activities without concern for how much cash is being used or how quickly. This may have no implications for a short period of time but will certainly become a problem when cash either runs out or more than usual is needed to fuel growth.

So how does cash “flow” in most organizations?

It’s well worth outlining how cash flows in almost all organizations. At the most basic level, we can say that cash flows in two directions – it flows positively, or is accumulated, in organizational assets and it flows negatively or is spent in organizational liabilities. Let’s look at these two categories in more detail individually.

A) Cash Assets

There are six major cash asset categories in most business as follows:

1. Revenues: Revenues paid to the business by customers are a precious asset and are a very quick way to build up bank account reserves or increase positive cash-flows. The most favored ways to do this is to find more customers, get them to buy more in terms of products and services, increase prices or speed up payment (pre-pay or part pay up-front for example). However, not only does this take time but needs to be done with great care, especially if your business operates in a highly competitive market, where the customers may go elsewhere if they don’t like what you are doing.

2. Deposit bank accounts and fees: Business bank accounts often have more money in them than is needed to run day-to-day or month-to-month operations. Once cash need peaks and troughs are known, any excess cash can be put in either an “at-call” investment account (any bank will advise you on how to do this) or used as further investment in the business. A business can also look at making greater use of electronic payment and “locked box” services to help increase cash-flow and reduce fees.

3. Accounts receivable: Accounts receivable are all of the payments you expect to receive from customers having supplied them with goods and services on credit (assuming that you do of course). This is effectively a short-term loan to your customers and it is worth reviewing whether the terms of this loan (in terms of days allowed to pay) are too generous. Even if they are not, steps can be taken to better manage the receivables to reduce days outstanding. The best way to do this is to evolve a full payment strategy and implement it. This might include making more payment options available, factoring debt or even selling your receivables to a third-party collection agency.

4. Depreciation: Recording depreciation expense decreases the organizational value in the books of long-term fixed assets. Each year, the business converts part of the total cost invested in its fixed assets into cash (although there is no cash outlay when recording depreciation expense). The business recovers this amount through cash collections from sales. As a result, depreciation, especially when it is accelerated, is a positive cash flow factor.

5. Equity: Equity, as opposed to debt, is the business owner’s contribution to assets. Although this will have been provided to start a business, there is sometimes an opportunity to go back to existing investors and raise more money from them or to bring in new investors. The downside of this is that a business may have to give investors more overall ownership of the business but it can bring in much-needed lump-sum cash, especially when it is needed for special or capital-based projects which are focused on new markets or growth perhaps.

6. Loans: Loans are debt from lending institutions such as banks. Loans clearly bring cash into any business in the short-term but there are two longer term factors to consider when raising cash this way. Firstly, interest payments will be a future cash outflow and the ratio of debt to equity will be less positive to both a business’s shareholders and the bank and may mean that they may look to change the relationship to move more in their favor in return for this change.

To increase the positive flow of cash in every one of the above you should generally raise them (although this has to be done carefully and judiciously of course). Hence in summary, revenues can be raised, deposits in the bank increased, accounts received more quickly, depreciation hastened, equity contributions lifted (shareholder cash) and loans sought.

B) Cash liabilities

There are also six major cash liability categories in most businesses as follows:

1. Cash expenses: Cash expenses are those payments that a business has to make in real cash terms (other than labor). Examples might be telephone or internet payments, stationary costs or business vehicles acquisitions. The higher these are the more they deplete cash reserves so these liabilities are best lowered by buying less, slowing down the payments or paying for such items over a longer period of time (and even renting).

2. Staffing/labor: Staffing is a particular expense that consumes cash and is tied up in base salaries and benefits but also in extra costs such as overtime payments, when made. Although staff can be cut, not replaced when people leave and not given as much overtime, for instance, one of the best ways to lower cash expenditures here is to get more productivity from labor. For example, fewer people may produce 25% more goods in return for a bonus system which pays only when finished goods sell (and at a rate that is much less than overtime payments). 

3. Raw materials purchasing: Raw materials purchasing is like cash expenses but should ideally be done as a cost of sales item. However many businesses buy more raw material than they need or can sell fast enough, which again lowers capital reserves. These are best lowered by buying less or only as you need raw materials, slowing down the payments and by paying for such items on longer payment terms (or sometimes on credit until you can sell the finished goods). A business can also look for greater volume discounts here.

4. Work-in-progress/inventory: Although it is a sub-set and consequence of raw material purchasing, work-in-progress and inventory in any business are all the part-finished and fully-finished goods and services that have yet to be sold. Many businesses do not spend enough time focusing on this (as it is a difficult balancing act) and it ties up far too much cash as a result). The solutions here are in scrutinizing all internal processes for quality, waste and product return problems but also looking for supply which is more “just-in-time” oriented (usually by working with key suppliers in partnership to bring this about, as they have a big stake in a business customer succeeding and continuing to buy from them).

5. Accounts payable: This is the other side of accounts receivable category in cash assets. Payables are what the business owes to its suppliers and other debtors. Paying these out “on terms” is a liability but if you are paying these out before they are expected (ahead of terms) it is a greater drain on cash than necessary). You can also either negotiate payment terms to be longer to slow down the draw on cash reserves or just pay more slowly. In both cases this is unlikely to be popular and may negatively affect the relationship with suppliers (and may result in poorer future service) if not done with great care.

6. Interest/dividend payments: Interest is paid to lenders on loans to the business and in terms of any dividends the business pays to shareholders, as applicable. Both of these are real cash outlays, although interest payments are made every month typically and dividends are paid quarterly, six-monthly or even annually. There is little room to change the impact on cash here other than negotiation. A bank may possibly lower interest rates or allow an interest vacation for a short period (but usually only as a once-off change). Shareholders may also be prepared to accept lower or no dividends or agree to re-invest them in the business, subject to their acceptance of this approach.

To decrease the negative flow of cash in every one of the above you should generally lower them (although again this has to be done carefully and judiciously of course). Hence, in summary, cash expenses can be lowered, raw material and other purchasing costs slowed, staffing costs lessened, inventory and work-in-progress reduced and interest/dividend payments cut back in some way.

Why does all this matter to the average leader?

Many of the above categories on both the asset and liability side of things are managed by specialists in a business such as accountants (cost, financial and management kinds), analysts, bookkeepers, buyers, inventory specialists and others. However, most of these roles are there to either record the flow of money or analyze cash flows after the event or as they have occurred historically and not in the real-time way that they should be assessed and managed in ideal circumstances. As a result, it is far better for all managers to deepen their understanding of how cash flows into and out of the business, and particularly into and out of their part of it (a team, department or entire division) and then play their full part in controlling cash-flows more effectively. The better managers get at doing this the better it is for the team and the organization as a whole.

Summary

Nothing in business is more important than the effective management of cash. Cash is the lifeblood of business. Therefore, senior managers in all organizations should make the monitoring of cash flow and the management of cash resources (assets and liabilities) a priority.

In order to ensure that there are no major unplanned losses of cash due to catastrophic events the organization should also be involved in efficient risk management. By the judicious use of investments and effective use of temporary borrowings, management can maintain adequate cash flow and thereby maximize profits.

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About Dr. Jon Warner

Dr. Jon Warner is a prolific author, management consultant and executive coach with over 25 years experience. He has an MBA and a PhD in Organizational Psychology. Jon can be reached at OptimalJon@gmail.com

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2 Comments

  1. Kelly BorosMay 29, 2014 at 8:16 pm

    “If you are paying these out before they are expected (ahead of terms) it is a greater drain on cash than necessary.”

    A lot of businesses operate under a “clean desk” rule – meaning they pay and invoice the minute it comes in. This is done to reduce the risk of forgetting to pay a bill. However, it does put a lot of strain on cash flow. Prioritizing invoices and creating reminders (written and digital) allow you to take advantage of the terms put forth by your vendors and suppliers, which helps free up cash flow.

  2. Robert BrownJune 26, 2014 at 6:34 pm

    Cash flow is the money that is moving (flowing) in and out of your business in a month. Cash is coming in from customers or clients who are buying your products or services. If customers don’t pay at time of purchase, some of your cash flow is coming from collections of accounts receivable.Think of ‘cash flow’ as a picture of your checking account. If more money is coming in than is going out, you are in a “positive cash flow” situation and you have enough to pay your bills.

About the Editor and Primary Author

Jon Warner

Jon Warner is an executive coach and management consultant and in the past has been a CEO in three very different companies. Read more

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