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  • Juanita Schwartzkopf

What are the easiest ways to improve cash management?

The combination of high interest rates and inflation have caused many businesses to think about improving their cash management processes.  What are the easiest ways to improve cash management, which in turn helps reduce anxiety tied to liquidity needs?

First, prepare a weekly cash receipts and disbursements forecast.  This forecast should not be directly tied to the income statement as a cash forecast needs to evaluate how cash actually moves through the business. 

For example, if the company uses premium financing for insurance, there is a difference between cash and accrual accounting.  For accrual accounting, the insurance expense is divided between the covered months.  For cash planning, a larger down payment is due at the time the insurance is placed, and then payments occur for a period of months less than twelve.  If the cash flow does not consider this difference, there will be a surprise when the down payment is due.

Also, for example, revenue would be reported on the income statement when the sale is booked.  However, the cash would be collected based on payment terms.  If the cash flow does not consider this difference, companies will not understand the impact of seasonality or other changes in revenue levels or customer concentrations.

Once the receipts and disbursements are forecast, then consider the opening cash balance.  Be aware of book balance versus bank balance.  Make sure any held checks are considered.   The correct starting point for cash balances, and the understanding of how receivables are collected and deposited, and how payments are made, all will impact the book and bank cash balances.  The cash flow needs to evaluate both balances, and how a revolving line of credit structure impacts the cash flow through the company.

Next develop roll forwards for key working capital components.  The work on the cash receipts and disbursements, and the book and bank cash balances with line of credit structures should result in a roll forward of cash.

Do not stop with a cash roll forward.  Develop roll forwards for accounts receivable, inventory, accounts payable and the line of credit.

The accounts receivable roll forward forces the cash flow to consider that in the early weeks existing accounts receivable impact possible collections.  The roll forward allows a cash forecast to be tied to payment terms and customer payment frequencies.  Consider evaluating cash receipts for the previous three to six months, or preferably a year, to determine any cycles that exist.  Do not use simple averages such as days sales outstanding.

Inventory roll forwards can be intimidating, but this roll forward is key to planning cash flow needs.  If a company is adding new products or customers, or if the company has seasonality or growth plans, inventory would likely increase prior to the sales and accounts receivable increasing.  That use of cash needs to be forecast.  If sales are expected to decrease, preparing the roll forward will ensure decisions can be made to reduce inventory investment in time to impact the overall investment in inventory. 

An accounts payable roll forward is a critical planning tool.  In some cash flow models, companies do not roll forward accounts payable and the company misses the growth in accounts payable caused by matching receipts with disbursements, coupled with line of credit availability.  Without an accounts payable roll forward, the company does not have visibility into the need for vendors to increase their support of the business.  In some situations, companies will need to consider vendor lines of credit limits and will need to develop roll forwards by key vendors.

Consider a situation where the cash forecaster matches disbursements to forecast receipts and holds the line of credit balance to a percentage of accounts receivable and inventory. That approach would miss a buildup in accounts payable past a reasonable number of days outstanding.  In one situation a company increased its accounts payable but did not report the level of payable to the lender.  The company would not embrace a working capital component roll forward.  By the time the lender became aware of the increasing level of payables, vendors had the company on prepayment terms and the operating cycle of the company was broken.

The line of credit roll forward is not as simple as it sounds.  The roll forward of the line of credit requires a detailed weekly forecast in a similar format as the borrowing base certificate.  That means forecasts for ineligibles will need to be developed and advance rates will need to be considered for resetting.  Many inventory appraisals have been showing worsening recovery values and lenders are finding themselves over advanced after a new appraisal.

The weekly borrowing base forecast is important even if the company only produces a monthly borrowing base certificate for its lender.  The weekly forecast will provide early warnings of changes in the borrowing base components that will impact availability in future weeks.  Imagine a monthly BBC submission that reduces availability below the line of credit outstanding balance.  That means the company has converted working capital components to cash but has not reduced reliance on debt.

Do not expect the weekly cash flow, working capital roll forwards, and borrowing base estimates to be accurate the first time.  Cash flow forecasting is a skill that is learned.  Start with a model and then expand and develop the cash flow forecasting based on budget to actual reporting.

The cash flow model improves as budget to actual reporting occurs.  Do not simply put actual results for a week in a cash flow and then immediately reforecast the cash flow.  Focus back to a weekly cash flow, working capital roll forwards, and borrowing base forecast as a starting point.  Track performance to the starting point – weekly and cumulative tracking.  That tracking will allow the forecaster to continue to grow in skill, and improve the forecast. 

There is no excuse for not having a cash forecast.  The managers of a business need to require that important planning tool as a base to support sales, marketing, and operational changes.

1 comment

1 Comment

Apr 04

I prefer using a 13-week cash flow worksheet regardless whether the cash is inbound or outbound or included on the P&L, the Balance Sheet or Statement of Changes in Cash Flow.

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