Article by Shepherd Kembo
This week we seek to share the importance of cash flow management as a management tool for investors, every aspiring businessperson and aspiring business manager. We will seek to unveil and unpack why every businessperson needs to understand the importance of having the financial figures of their business on their fingertips, if they are to run a business successfully. The article will seek to explain the importance of cash flow management. Our analysis is not from a technical financial accountant point of view, but for the grasp and understanding of a standard manager, investor or business person.
The article on cash flow management will seek to reduce complex Financial and complicated spreadsheets to basic addition and subtraction mathematics, so simple that anyone at managerial level can grasp and understand. For this basic management tool, we will divide the financial report into five basic categories of (Top line) sales or revenue, (second line) cost of sales (third line) operating costs, which are running expenses and overheads, (fourth line) Capital expenditure and Dividends and (bottom line) being Profit. We will not delve into Profit After Tax.
For the sake of easy understanding we will seek to treat this subject matter as simple as follows: Sales (revenue) minus Cost of Sales=Gross Profit less running expenses and overheads = Profit Before Tax. Capital Expenditure and Dividends come after Tax.
What is cash flow management? Who should understand and grasp cash flow management?
For the sake of this article, let us use the following definition for cash-flow management: Cash flow management is the process of monitoring, analyzing, and optimizing the movement of money coming into and out of a business. To illustrate the way to look at cash flow management for non-financial leaders, we will use a brief case study on cash flow management.
An Executive Manager with no financial qualifications was heading a group of several business units with qualified Accountants responsible for the accounting functions. These expert Accountants used to give him torrid times when giving financial reports, feedback and updates on progress on various projects that the group was working on. Some of these expert Accountants would deliberately seek to frustrate the Executive Manager when giving such operations updates and feedback by using highly complicated financial jargon. When the Executive Chairman realized his Senior Manager’s dilemma, his advice was: As the senior Executive manager. do not seek to compete and match the technical expertise of your subordinates for the sake of it.
They are expected to give you refined and distilled information for decision making. When your subordinate financial and technical experts seek to elevate the conversation to a level beyond your grasp and understanding refuse to be dragged down that unnecessary path. Take it simple and basic, and tell your subordinates this “I do not seek to be a technical financial expert to understand and manage the business, I seek to understand as a shareholder steward and custodian, how much money we have put into the project, how much are our expenses, how much is our return on investment, how much was the profit and most important, how much cash we have on hand.”
Managing cash flow is one of the most critical functions in business management. Some experts on business management will go so far as to say that in the short-term having a positive cash flow situation in a business is more important than showing a profit. Once a business has a positive cash flow position, it can make a profit in the future. But a profit with no cash may bring the business to a grinding halt. Managing cash flow should be understood at all levels of the business where the incumbent is in charge of holding stocks and selling goods and ensuring timely payment, no matter how small the outlet may be. Even street vendors need to understand the concept of cash flow management.
To illustrate this very important point, one of the leading fast foods industry players in Zimbabwe listed and doing well on the Zimbabwe Stock exchange has drilled and in-calculated this noble business practice of cash flow management right down to their individual small street corner shops to the shop floor level. All their employees, heading these small little shops regardless of their educational qualifications and competence and disposition, have been trained to complete daily standard cash flow forms that are consolidated to weekly and monthly individual branches cash flow sheets that are forwarded to head office for group monthly and annual financial statements input.
These shop floor branch managers have been exposed to the most critical management tools and practice essential for decision making.
How to manage Cashflow.
Cashflow management is a summation of managing the first 3 levels referred to earlier in this presentation. We will look at them separately.
1. Cash inflows, or sales revenue management.
To maximize cash inflows, management has to do the following
-achieve or exceed budget sales targets
-maintain or exceed gross profit margins. There may be cases were reducing margins could result in increased sales giving overall higher gross revenues.
Managing sales may also entail doing the following
Offer cash or early settlement discounts
Maintain strict credit policies that includes stringent vetting for qualification for credit terms.
Maintain strict enforcement of payment terms
Implement timeous processing of invoices and customer statements.
2. Cost of sales management,
To reduce cost of sales, management has to do the following:
-buy goods and services for production or resale at most competitive prices
-negotiate the most generous payment terms possible
3. Production and selling costs management.
-production and selling costs is the difference between sales and gross profit. If these are not managed, gross profit will shrink and available cash will diminish.
4. Overhead costs
In most cases of cash flow management failure, overheads are usually the elephant in the room. Management usually struggles with cutting overheads costs. It is, however, most
critical to ensure that overheads are always aligned to the current level of business activity.
5, Although not included in the computation of Profit before Tax computation, Capital Expenditure is a major cash flow item.
In a tight cash flow situation, it is necessary to minimize capital expenditure. Besides deferring unnecessary capital expenditure, consideration could also be given to leasing instead of buying, and when it is feasible to do so, renting instead of owning the premises.
6. Stock management is equally critical in managing cash flow.
The “Just in Time” management system was developed as a cash flow management strategy. Stocks of raw material inputs and finished goods are idle cash. Any excess stock is a subtraction from available cash. A good balance of stocks means good cash flow management. While bulk buying may be cheaper, it should be done taking into account the business’s cash flow position.
Cash flow leads to profitability and offers competitive advantage.
Cash flow leads to profitability and offers a competitive advantage to your business. Once there is good cash flow management, there is need to separate and classify cash flow into various categories, that is operating cash flow that helps to avail daily, monthly working capital, investing capital and financing capital for growth, research, diversification and expansion and paying dividends to shareholders.
However, if not managed effectively, negative cash flow can lead to corporate failure.
Disclaimer:
This article has not been written as a financial expert portrayal, but from a business practitioner perspective based on day-to-day operational experience. It is not based on any research. but on practical management experience and with the objective of sharing practical experiences.
Shephard Kembo is a managing partner at Globavel International Pvt Ltd. He can be breached at whatsapp +27 78 389 37 57, whatsapp +263 772 446 731, [email protected]
