Chapter 13 Lecture.docx - Managing Cash Flow Introduction...

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Managing Cash Flow Introduction Running out of cash has driven countless small companies into bankruptcy. A cash forecast is essential for new businesses because they usually do not generate positive cash flow right away. It is essential to collect accounts receivable. New businesses must forecast how much cash the company will need to get through the valley of death , which is the time period during which start-up companies experience negative cash flow as they ramp up operations, build their customer bases, and become self- supporting. Refer to Figure 12.1, The Valley of Death. Cash Management Cash is the most important, yet least productive, asset that a small business owns. Businesses must have enough cash to meet their obligations or run the risk of declaring bankruptcy. It is entirely possible for a business to earn a profit and still go out of business by running out of cash. Disruption to cash flow is most often caused by customers paying their bills late or not at all. The Great Recession has intensified this problem, as demonstrated in Figure 12.2, Small Business Owners’ Ratings of Their Companies’ Cash Flow. Cash management is the process of forecasting, collecting, disbursing, investing, and planning for the cash a company needs to operate smoothly. Any excess cash should be invested, even if for a short time. Managing cash flow is also an acute problem for rapidly growing businesses, which are also likely to run out of cash to meet the needs of a growing business with a booming sales volume because of the requirement to hire more employees, expand plant capacity, etc. Refer to Table 12.1, Signs of an Impending Cash Flow Crisis, and Table 12.2, How Much Cash Is Required to Support an Increase in Sales? The first step in managing cash more effectively is to understand the company’s cash flow cycle which is the time lag between paying suppliers for merchandise or materials and receiving payment from customers. The longer this cycle, the more likely the business will encounter a cash crisis. Refer to Figure 12.3, the Cash Flow Cycle.
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The next step is to analyze their cash flow cycle, looking for ways to reduce its length. Business owners should calculate their cash conversion cycle whenever they prepare their financial statements, at least quarterly. On a daily basis, business owners should generate reports showing the following: total cash on hand, bank balances, a summary of day’s sales, a summary of the day’s cash receipts, summary of the day’s cash disbursements, and a summary of accounts-receivable collections. Cash and Profits As important as earning a profit is, a company’s survival depends on its ability to generate positive cash flow. Profitability is not necessarily highly correlated with cash flow. Cash and profits are not the same. Profit is the net increase over a period of time in capital cycled through the business, indicating how effectively the firm is being managed.
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