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Effective procedures vital in cash flow management

Posted online

by Larry W. Zahn

for the Business Journal

"Why are we always struggling to meet our financial obligations?"

If your business is like many others, you have asked this question, or one similar to it.

You may be able to correct this situation by developing effective cash management procedures.

Here are some general guidelines on procedures you can implement to improve cash flow.

The basics.

Effective cash management lets you control your working capital, the difference between your current assets and current liabilities. One part of the equation requires converting noncash current assets into cash within a proper time period. The other part requires controlling current liabilities.

Many factors affect the way cash flows through your business some you can control and others you have little or no control over. Here are a few areas you can control.

Bringing the cash in.

?Accounts receivable. If your business relies on credit sales, management of accounts receivable can have a major impact on your business, both in your ability to bring cash in and in the time it takes you or your employees to deal with the process.

An often-overlooked step in the credit process is the development of documented policies and procedures for receivables.

This includes accepting new customers, establishing credit limits, billing procedures, collection policies on delinquent accounts and authorization for writing off bad debts. Even if you already have policies, now might be the time to review whether they are effective and being followed.

The most important factors in dealing with receivables are the collection policies in place and evaluating the age of your receivables.

The collection policies should include the methods to be used to follow up on delinquent accounts (number of contacts, documentation, etc.) and establishing when accounts should go to collections or be written off.

The aged accounts receivable report helps you manage collections and evaluate the age of receivables. The report, which management should prepare and review on a regular basis, shows balances in groupings such as current and more than 30, 60 and 90 days, reflecting the number of days past due.

The ratio for days in accounts receivable is another tool to help you manage receivables.

This ratio average accounts receivable divided by total sales for the period divided by the number of days in the period represents the average day's sales in accounts receivable. Compare both this ratio and the percentage of balances in each category of your aging report to industry benchmarks.

?Inventory. Excessive inventory levels and slow-moving or obsolete inventory items are the usual culprits in diminishing cash flow. Monitor your inventory in much the same way you monitor receivables, reducing your exposure in these areas.

The key ratio for inventory is the number of times inventory turns over during the year. Calculate this ratio by dividing cost of goods sold for the year by average inventory.

While this ratio serves a purpose when calculated for inventory as a whole, you can extract much more valuable information when you calculate it for a product line or even each inventory item.

At the lower levels you can quickly identify slow moving items or where excess is starting to build. Again, compare the results to averages for your industry.

Obsolete inventory can be identified and converted to cash. While you will likely take a substantial discount on these items, you can put the cash provided by the sale to a much more productive use than the idle inventory.

Also, make sure you have adequate policies and controls in place to reduce the possibility of the situation recurring, as well as reducing the risk of shrinkage.

Sending the cash out.

Hold on to your cash for as long as possible while still meeting current obligations on a timely basis. If an invoice is due on the 30th, there is no benefit to you in paying it on the 10th.

Obviously, consider taking discounts offered by vendors when they are available and require payments to be issued only against invoices.

Cash flow forecasting software can help you identify when short-term borrowing might be needed.

If this is a part of your accounting system, use it to pull information from your receivables and payables to project cash requirements, which may help you negotiate more favorable terms.

You can improve cash flow by monitoring and controlling the financial side of your business. By implementing the appropriate policies and procedures, and understanding the information available, you can obtain the benefits of improved cash flow.

(Larry Zahn is a CPA and an operational consultant with the Springfield office of Baird, Kurtz & Dobson, certified public accountants.)

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