M. Ferrara & Sons - News

ABC Company is growing and making a good profit. However, there never seems to be enough cash to pay the bills. This month, for example, the business insurance premium had to be paid with a credit card. What is wrong with this picture?

ABC Company has what is known as a "cash flow problem." That means that cash flowing into the business is out of synch with the cash moving out. The result is that the business is temporarily caught short when bills come due. The management of ABC Company needs to plan ahead so they will know whether or not they will have enough cash available when they need it.

How many of you have had something similar happen to you? Business analysts report that poor management is the major reason why most businesses fail. It would probably be more accurate to say that business failure is due to poor cash management. So how can you manage your cash situation better? Let's take a close look at the cash flow process to find out.

WHAT IS CASH?
Cash is ready money in the bank or in the business. It is not inventory; it is not accounts receivable (what you are owed), and it is not property. These might be converted to cash at some point in time, but it takes cash on hand or in the bank to pay suppliers, to pay the rent and to meet the payroll. Profit growth does not necessarily mean more cash - as we will see.

A lesson that all entrepreneurs learn is the difference between profit and cash. In the long term, profit is the amount of money you expect to make if all customers paid on time and if your expenses were spread out evenly over the time period being measured. However, it is not your day-to-day reality. Cash is what you must have to keep the doors of your business open while you are busy trying to make a profit. Over time, a company's profits are of little value if they are not accompanied by positive net cash flow. You can't spend profit; you can only spend cash.

WHAT IS CASH FLOW?
Cash flow simply refers to the flow of cash into and out of a business over a period of time. Watching the cash inflows and outflows is one of an owner's major management tasks. The outflow of cash is measured by those checks you write every month to pay salaries, suppliers and creditors. The inflows are the cash you receive from customers, lenders and investors.

POSITIVE CASH FLOW
If the cash coming "in" to the business is more than the cash going "out" of the business, the company has a positive cash flow. A positive cash flow is very good and the only concern in these circumstances is what to do with the excess cash. Like good health, a positive cash flow is something you are most aware of it you don't have it.

NEGATIVE CASH FLOW
If the cash going "out" of the business is more than the cash coming "in" to the business, the company has a negative cash flow. A negative cash flow can occur for a number of reasons. For example: too much inventory or obsolete inventory or poor collections of your accounts receivable (what your customers owe you) can cause you to be short of cash. If the company can't borrow additional cash at that point, the company may be in serious trouble.

WHAT ARE THE COMPONENTS OF CASH FLOW?
Cash flow as reported on a Cash Flow Statement is typically divided into three components so that you can isolate and understand the sources and uses of cash. These components include internal and external sources:

• Operating Cash Flow
  Operating cash flow, often referred to as working capital, is the cash flow generated from internal business operations. It is the cash generated from and/or the sales of products and/or services of your business. It is the real life blood of your business; and because it is generated internally, it is under your control.
• Investing Cash Flow
  Investing cash flow is generated internally from non-operating activities. This component would include investments in plant and equipment or fixed assets, certain nonrecurring gains or losses, or other sources and uses of cash outside of normal operations.
• Financing Cash Flow
  Financing cash flow is the cash paid to and received from external sources, such as lenders, investors and shareholders. A new loan, the repayment of a loan, the issuance of stock and the payment of dividends are some of the activities that would e included in this section of a Cash Flow Statement.

HOW DO I PRACTICE GOOD CASH MANAGEMENT?
ABC Company might have been able to avoid using a credit card to pay an "unexpected" bill if management had been practicing good cash management. Good cash management is simple. It means:

• Knowing when, where and how your cash needs will occur;
• Knowing what the best sources are for meeting additional cash needs, and
• Being prepared to meet these needs when they occur, by cultivating good relationships with bankers and other creditors.

The starting point for avoiding a cash crisis is to develop a cash flow projection. Smart business managers know how to develop both short-term (weekly, monthly) cash flow projections to help them manage daily cash flow and long-term (annual, 3-5 year) cash flow projections to help them develop the necessary capital strategy needed to meet their business needs. They also prepare and use historical cash flow statements to develop an understanding about where all the money came from and went.