Managing Cash FlowAn Operational Focus phần 10 pot

Interpretation and Analysis of Cash Flow 317• Sales • Types and amount of sale • To the right customer • Of the right product • At the right time • Relationship to sales forecast • Real

Interpretation and Analysis of Cash Flow 317

• Sales

• Types and amount of sale

• To the right customer

• Of the right product

• At the right time

• Relationship to sales forecast

• Real customer orders recorded in original sales forecast

• Real customer orders forecasted

• Addition to original sales forecast

• Sales forecast not realized

• Paid within discount period

• Discounts taken but paid after discount period

• Payments relative to terms period (e.g., 30 days of invoice date)

• Between 10 and 20 days

• Between 20 and 30 days

• Beyond 30 days, 60 days, 90 days

• Collection procedures employed

318 Controlling and Analyzing Cash Flow

• Change in accounts receivable

• Increase or decrease in total

• Payment practices (i.e., quicker, slower)

• Cash sales versus accounts receivable sales

• Costs and pricing

• Product costs

• Direct labor: Change in set up and processing time and dollar costs

of rejects and rework

• Material costs: Changes in quantities, amount put into production,cost of scrap and rework

• Sales support prior to and during sale

• Customer service—type and level

• Type of distribution (one shipment, drop shipment, numerouslocations)

• After sales support

• Differential pricing

• Related to product, functional and customer costs

• Based on method of payment (e.g., cash on delivery [COD], counts, terms)

dis-• Profit center concept (e.g., each sale, total sales)

• Vendors and accounts payable

• Cash payment if invoice amount less than processing cost

• Cash payment as part of vendor price negotiations

• Changes in accounts payable

• Payment indicators (e.g., discount taken, payment within terms, ment beyond terms)

pay-Interpretation and Analysis of Cash Flow 319

• Real orders/total mix

• On-time moves and completions

Cash Flow Ratios: Operational and Financial

There are basically five major sources of cash and a corresponding five major uses

of cash These are as follows:

1 Profits from operations 1 Losses from operations

3 Sale of equity 3 Payment of dividends

4 Sale of assets 4 Investments/acquisitions of assets

5 Decrease in working capital 5 Increase in working capital

We have already discussed that acquiring cash from profits and expendingcash for investment and acquisitions are the preferable sources and uses—at leastover the long term Profits represent a major reason why companies are in busi-ness—they are a principal goal of many organizations While borrowing and sale

of equity are a necessary part of business financing, they are less desirable sources

of cash than profits New borrowing will have to be repaid—with interest Newequity is expensive—and often unwanted or unavailable, especially to smallerbusinesses Sale of assets as a source of funds is obviously self-limiting And work-ing capital reduction as a source of cash is also generally restricted because of itsinherent operational limitations

On the other side of the ledger, the company certainly hopes to avoid ating losses Repayment of debt, while legally necessary, does little to directly ben-efit the organization Dividend payments benefit stockholders, but do nothingdirectly to help the company; and an increase in working capital ties up cash,which is something management wants to avoid Reinvestment in assets, how-ever, indicates a commitment to the future—assuming the investment is done in a

oper-manner that is intelligent and consistent with the company’s strategic planning Itshows the company’s interest in future survival and growth and can be seen as apositive statement about progress and advancement.

CASH FLOW RATIOS—AN OPPORTUNITY

FOR CREATIVE THINKING.

With these basics in mind, the company’s Statement of Cash Flows can beanalyzed with ratios A generally accepted set of cash flow ratios does not yetexist, so the company must look at its own operational and financial position andneeds in devising analytical techniques to evaluate its cash flow Acceptable andunacceptable results will vary from company to company, but norms will emergefor the organization based on its specific uses of cash over a three to five year peri-

od The ratios illustrated below, or modifications of them, can be used to develop

a working cash flow evaluation process for the organization Most of the ratiosfocus on the impact of various measures relative to cash flow from operations,which is the most significant cash flow element

There are any number of additional possibilities that could be considered aswell The major problem is not to come up with additional ratios, but to determinewhich of the myriad possibilities make sense for the company The ratios beloware intended to be idea generators only and should not be construed as a general-

ly accepted set of ratios Such a set has yet to be developed

Ratio Cash flow from continuing operations to

sales The amount of operating cash

flows generated by sales—a cash

effi-ciency measure

Cash to income ratio Percentage of

operating income that has been

con-verted into cash—a measure of cash

conversion

Cash sales to total sales The amount of

sales immediately converted into

cash—a cash efficiency measure

Reinvestment ratio The amount of

operating cash flows used for capital

expenditures—a measure of the degree

Purchase of property, plant & equipmentOperating cash flows

Cash Flow Reporting and Controls 321

Ratio Reinvestment adequacy The amount of

reinvestment relative to depreciation—

a measure of the adequacy of capital

reinvestment

Operating cash reinvestment ratio How

much of operating cash flows is being

reinvested in the business—a measure

of the degree of capital reinvestment

Reinvestment to sales The percentage of

sales reinvested – a capital

reinvest-ment measure

Financing ratio The percentage of sales

used for financing the business

Debt payoff The amount of operating

cash flows used to pay off debt

Cash return on assets The amount of

cash generated from total asset

invest-ment in the business—a cash return on

investment (ROI) measure

Cash return on equity An ROI measure

of cash return on stockholder’s equity

Cash return on capital employed An ROI

measure of cash return on capital

employed in the business

Cash flow current ratio Ability of cash

generated from operations to cover

currrent liabilities

Cash flow fixed charge coverage Ability

of operating cash flows to meet

com-pany fixed charge obligations

Debt repayment from operating cash flows.

Number of years of operating cash

flows required to cover debt

obliga-tions

Method of Calculation

Purchase of assetsDepreciation

Investing cash flowsOperating cash flows

Investing cash flowsNet sales

Financing cash flowsNet sales

Debt paymentsOperating cash flows

Operating cash flowsTotal assets

Operating cash flowsStockholders equity

Operating cash flowsCapital Employed

Operating cash flowsCurrent liabilities

Operating cash flows  fixed charges*

Fixed charges

*(interest paid  taxes paid  other fixed charges paid [rent, debt principal, leases, etc.])

Total debtOperating cash flows

To be of maximum value, any ratios used should be measured over a three

to five year period so that trends can be evaluated rather than just absolutes.Without a set of norms, absolutes have virtually no significance, and those normswill have to be developed individually for each company Finally, any evaluationshould always revert back to the basics of cash flow discussed earlier—cash overthe long run should come primarily from profitability (operating cash flows)and should be used primarily for reinvestment in the business (investing cashflows), with financing cash flows serving as the balancing number between theother two

It is reasonable to presume that accounting practitioners and analysts willeventually develop a workable set of cash ratios that form the basis of a generallyaccepted set of cash flow ratios comparable to the financial ratios now being usedfor income statement and balance sheet analyses In the meantime, the companywill have to identify the information it needs to manage the company’s cash Theabsence of an acceptable set of already developed ratios does mean more work forthe analyst, but it also means fewer restrictions and the chance to be creative andinnovative in analyzing the company’s results That is an opportunity not to bewasted

CONCLUSION

Analyzing the cash management process within an organization is an effectivetool for determining the economy, efficiency, and effectiveness of the company’suse of its cash flow It forces management to move away from strictly accountingdata and look at operations from a cash flow viewpoint, eliminating the perplex-ity of financial statements that are produced on the accrual (rather than cash) basisand contain numerous noncash accounting treatments By taking the cashapproach to analyzing operations, the analysis strips the business down to thoseongoing operations that either add or deduct cash from the company’s activities.This enables management to get to the essence of the company’s operations andgain greater insight as to what is actually happening operationally within theorganization

CASH FLOW ANALYSIS

IS OPERATIONS ANALYSIS.

AFTERWORD

The materials in this book are intended to provide the guidelines and

direc-tions that will enable the organization to take an operational focus on cashmanagement As we have attempted to point out, cash flow is not princi-pally a financial activity, but comes about as the result of the operations of theentire company Cash is generated from the company’s sales activities and is usedprimarily by company operations Everyone in the company is responsible for theuse and conservation of cash It is not solely management’s responsibility to planand monitor the sources and uses of cash, but each employee’s responsibility aswell Management has overall responsibility for policies and direction, but if it canmake all employees their own profit centers, then it becomes everyone’s individ-ual responsibility to maximize income, minimize expenses, and optimize expect-

ed results with efficient use of resources, and ensure a continuing positive flow ofcash so the organization can survive and thrive Accordingly, cash managementmust be fully understood and practices effectively followed by all companyemployees

Before the reader closes these pages and shelves the material, we also want

to call attention to the Case Study and the Cash Conservation Checklist followingthis Afterword The Case Study – on Jack B Nimble Company – was brieflyreferred to in Chapters 1 and 2, but is here presented in its totality We suggest thatthe Case Study be reviewed and worked out before turning to the suggested solu-tion This will provide an opportunity to apply some of the issues we have raisedwithin the pages of this book The Cash Conservation Checklist that follows theCase Study, is an attempt to show on a few pages some (and only some) of theissues the reader might consider when reviewing his or her own cash flow man-agement issues The Cash Conservation Checklist, because it is just a checklist, isnecessarily limited but might serve as a reminder of some concerns and issues andmight even trigger some new thoughts that could be applied to the specific situa-tion under review It is intended as an aid, not an all-encompassing solution

We realize that there are many operational areas and concerns that affectcash flow that we may not have discussed in the depth desired – or have omitted

entirely Sale/leaseback arrangements, initial or additional public offerings ofcompany stock, accounts receivable factoring, product licensing, mergers andacquisitions, non-traditional borrowing, and so forth are among the myriad addi-tional areas that should be further investigated as related to a specific company orsituation But we hope to have provided sufficient materials and ideas to encour-age the development of a comprehensive cash management program with anoperational focus for your organization

Cash management is a continual process It is also much more than just amanagement process – it is also an attitude that must be instilled within the entireorganizational culture Only with proper planning, effective operating practices,and diligent analysis and control can positive cash flow be maximized Cash man-agement is an exercise not only in controlling the expenditure of funds, but also

of generating cash from sales, effectively allocating and expending cash resources,and maximizing cash flow and profits The company must learn the best way inwhich it can achieve maximum desired results with the most efficient expenditure

of cash resources This has been the essence and purpose of this book We hopethat we have succeeded

LOVE OF MONEY IS THE ROOT OF ALL EVIL; ABSENCE OF MONEY IS THE ROUTE TO RUIN.

JACK B NIMBLE COMPANY

(formerly ABC Machining, Inc.)

Jack Nimble had been employed by ABC Machining for nearly 20 years, serving

in a variety of engineering and manufacturing positions for the company Thecompany owner decided to put the company up for sale, and Jack was eager tobuy it, since he knew he could do a better job of managing and running it thanwas presently being done There was potential for additional sales; and cost sav-ings through production efficiencies, superior customer service, and reducedadministrative expenses (the owner was quite generous to himself) would be easy

to accomplish Jack had no doubt that he could improve things dramatically

with-in a year, and growth possibilities after the first year were extremely attractive.Jack did not have strong financial skills, but he knew that he had to puttogether some kind of projected figures to set goals for the company and to satis-

fy his financial backers, who were members of his family and also not financiallysophisticated Exhibit A.1 shows the income statement projections that Jackprepared

Based on this projection, which he felt was realistic, Jack did not do any ther financial studies, nor did his financial supporters request any more data.Their feeling was that the combination of the sales growth and the attractiveimprovement in profitability would be enough to avoid any financial difficulties.Unfortunately, these projections proved insufficient Jack did not take intoconsideration three significant factors: (1) He would have to invest in excess of $2

fur-325

million in plant and equipment to gain all the efficiencies and throughput sion he required; (2) to gain the new customers required to achieve the sales tar-get, he would have to extend 30-day credit terms to all customers; and (3) it wouldtake time to ramp up to $1.5 million monthly sales necessary to attain the $18 mil-lion target figure.

expan-As ABC Machining, the company enjoyed a unique position—demand for itsproducts exceeded ability to supply The company was able to sell all of its month-

ly production of about $1 million on a continuing basis ABC required cash ment at time of delivery to virtually all customers, and was still able to sell 100percent of its output Jack, however, wanted to increase sales and net profits andrecognized the existence of increased competition and other changes in the mar-ketplace He not only saw the need to retain present customers but also to acquirenew customers To accomplish his goals, he knew he would have to offer creditterms for payment and would have to absorb the cost of carrying the significantincrease in accounts receivable investment

pay-Jack was fully aware of the plant and equipment investment and theaccounts receivable factors, but he did not understand the cash flow ramificationsthey would have on his fledgling business He simply assumed the profit gener-ated from the new sales would produce enough cash to cover any requirements

he would face He had not taken the ramping factor into consideration at all If hehad done a balance sheet projection, even without taking the ramping intoaccount, the pro forma balance sheet figures in Exhibit A.2 would have appeared,allowing him to plan for the cash shortage contingency

From the pro forma balance sheet, it is clear that Jack could have anticipated

a significant problem with cash Without that projection, however, Jack onlydiscovered the problem once in the middle of it Fortunately, because some of hisrelatives were willing to guarantee Jack’s loan, he was able to get a $1.5 million line

ABC Machining Jack B Nimble Co.12/31/x1 – actual 12/31/x2 – projected

December 31, 20x1 and 20x2 ($$ in 000s)

Jack B Nimble Company 327

of credit from his bank and to increase his long-term loan by $500,000 To completethe picture of his first year of operation, in Exhibit A.3 Nimble’s actual financialresults are shown compared to the projected figures and to the prior year numbers.Part of Jack’s problem (and the solution to his critical needs) was borrowing AtJanuary 1, 20x2, Jack assumed a loan of just over $1 million with a monthly pay-ment of $16,000 including interest at 81/2percent He added $500,000 to the loan onApril 1, 20x2, which increased the monthly payment to $25,000 but did not changethe interest rate He also negotiated a $1.5 million line of credit at a rate of 9 per-cent The actual cash flow, by month, for the year is shown in Exhibit A.4

From these figures, it is clear that Jack made good progress towards ing his goals During the year, however, his cash flow difficulties forced him todefer the purchase of certain equipment that he needed, and the impact on futureyears may be severe He did a good job controlling expenses and inventory, buthis accounts receivable went through the roof As a result, he is now dealing with

achiev-a significachiev-ant line of credit (achiev-and relachiev-ated interest chachiev-arges) He hachiev-as finachiev-anced the rest

of his requirements partly from the profits he was able to attain and from the tion to his bank loan, but also by not paying his vendors on time His accountspayable balance has increased dramatically, and is now about 85 percent higherthan it should be Jack’s phone is surely ringing off the hook with angry and frus-trated vendors who are looking for payment Additionally the bank is pressuring

328 Case Study: Managing Cash Flow

Jack B Nimble Company 329

Cash Forecast Information 333

him, insisting that he zero out the line of credit for at least one month before theywill consider another year’s extension

Because of his cash flow problems, Jack got smart quickly He decided heneeds a reliable cash flow projection for next year, particularly since he wants tocatch up on his fixed asset expenditures as well as make additional investments.The assumptions and estimates that support the forecast in Exhibit A.5 are asreliable as can be expected in the circumstances

FINANCIAL FORECAST INFORMATION

• Sales—January 20x3—$1,600,000; increasing at the rate of 1% per montheach month thereafter

• Cost of goods sold

• Variable CGS @ 40 percent of sales

• Fixed CGS @ $425,000/month, increasing at $10,000 per month for eachfollowing month

• Selling, general and administrative expenses (including bad debt expense,but excluding interest expense)

• Variable @ 10 percent of sales

• Fixed @ $55,000/month for six months, then $65,000/month

• Taxes—40 percent of profit before taxes

CASH FORECAST INFORMATION

• Accounts receivable collections

• 10 percent of current month sales

• 55 percent of prior month sales

• 34.5 percent of second prior month sales

• 0.5 percent uncollectible

• Cost of goods sold

• 100 percent of variable costs are cash

• 70 percent of fixed costs are cash

• Current month expenses are used as basis for projecting cash flow,although they are actually paid for at a later date

• Selling, general and administrative expenses

• $5,000 of fixed costs are noncash; all others are cash

• Current month expenses are used as basis for projecting cash flow,although they are actually paid for at a later date

• Operating cash—maintain minimum balance of $10,000

• Line of credit—9 percent interest on the prior month end balance

• Loan payments

• Interest @ 8.5 percent of outstanding balance

• $25,000/month repayment (interest included)

• Balance outstanding @ January 1, 20x3 = $1,346,100

• Subsequent months $200,000/month

The preparation of this kind of a forecast is not difficult once the basicassumptions and estimates are developed The picture such a forecast providesthe management of the organization is invaluable The prospect of an excessamount of cash is an opportunity that should be used to the fullest advantage,while a cash shortfall needs to be recognized early and handled wisely to mini-mize the cost to the organization and to avoid the disaster of not being able to payoff obligations Either way, typical income statement projections and pro formabalance sheets are not enough Cash is the ultimate determinant of survival, suc-cess, or failure

TASK

Review the cash flow projection in conjunction with the financial statements andother data previously presented in this case study Identify opportunities, bothfinancial and operational, for improved cash management and be prepared tomake suggestions to Jack that can help him get through his cash crunch and meethis bank’s demands

JACK B NIMBLE COMPANY CASE STUDY

SUGGESTED SOLUTION

There are many different cash management and operational areas to discuss

relat-ed to this case study The company faces a cash flow crisis that has been causrelat-edessentially by four factors:

1 Growth in sales without proper attention having been paid to the factthat growth is an expensive proposition, requiring cash for the increase

in accounts receivable, inventory, staff, and possibly equipment and/orplant