Managing Resources - Cash is King!

Introduction
“Cash is King. Without it a business cannot function” (Silbiger 2005: 95).  Leff (2003) states that, “cash flow is essential to a business’ health and is often a reliable indicator of the business’ income opportunities”; a view that McClearn (2006) concurs with.  Flanagan (2005) is also of the same opinion when describing the importance of cash flow within an organisation.  Flanagan (2005) describes cash flow as the “business’ life blood and every manager’s primary task is to help keep it flowing” (ibid) as well as using it to generate profit (ibid).  The role of accounting and the accountant ensures that cash flow statements are both generated and reported on accurately.  By ensuring that the cash flow is monitored, an organisation can keep a closer eye on other aspects of their financial statements to ensure their working capital is performing and generating profit.

Cash Flow Statement
With the information generated by the cash flow statement, managers are then able to look at the details and help put the balance sheet into perspective (Silbiger 2005).  For one to understand how the cash flow statement works, Silbiger (2005: 97) suggest that one must first understand the following mathematical equation; “Cash = CL + NCL + OE – AR – INV – NCA” (ibid).  He goes on to explain that any increase in Current Liability (CL) located on the right of the equals sign, will increase cash (ibid).  Meaning that by purchasing stock or equipment on credit, cash is available for other uses (ibid).  Furthermore, if the organisation purchases stock with cash, it will decrease the amount of cash in the business (ibid).  Therefore, purchasing stock on credit may be an alternative to up front cash payments.  However, care must be taken to ensure that inventories, debtors, creditors and cash are balanced and used wisely.  A company that is rich is cash, has the luxury of making demands on banks, partners and creditors.

Cash Management
Good cash flow also allows banks, the public and employees to view an organisation’s financial strengths and stability (Leff 2003 and McClearn 2006).  In addition “cash flow can be significantly enhanced if the amounts owing to a business are collected faster” (Flanagan 2006).  Most business insist that banks and finance companies conduct credit checks on businesses prior to any dealings.  A healthy cash flow statement will ensure that favourable results are presented in the findings.  When the business is healthy, its reputation is also increased allowing them to borrow larger amounts from banks and creditors.  It also allows the day to day operations of a business to function more effectively.

However, if cash flow isn’t properly managed, issues will arise.  For example, as cash was low and financial resources were overstretched (Flanagan 2005) in a company one had previously worked for, spending on vital items such as pens and paper could only be compared to (without insulting the tax man); filing a tax return.  Not only was morale low, ineffective and questionable working practises was the consequence.  On the other hand, companies such as those researched in the United Kingdom by REL Consultancy Group and cited by Atrill et al (2005: 371), do not utilise their working capital to its full potential (ibid), and therefore lose out on possible profit gains (ibid).

Managing Working Capital
Effectively managing working capital ensures that potential shortfalls are avoided.  It also allows businesses to manage debtors and creditors which will have a positive affect on the amount of inventory on the books.  The goal for any organisation is to firstly collect cash from creditors more quickly, secondly delay the payment of creditors without incurring interest and subsequently reducing the amount of inventory held (Flanagan 2005).  Control measures can then be defined such as invoicing companies and insist that payments are settled within thirty days, suspending future purchases on credit if accounts are not settled.  By implementing controls such as these, a company arms itself with the correct tool set that will allow them to identify potential bad investments and bad partners.  On the other hand, it will also allow them to identify company’s that will contribute to the profitability of the organisation, ensuring that they are well looked after.  When these processes are effectively carried out, an increase in potential profit may be achieved as pointed out by REL Consultancy as cited by Atrill et al (2006).
Conclusion
Effectively managing an organisation’s working capital increases the likelihood for the business to be successful and profitable.  True profitability is an organisations ability to generate “cash” more effectively.  Flanagan (2005) summarises this very well; “Time is money” (ibid).  The cash flow statement allows this movement of cash to be highlighted.  Without cold hard cash, survival is unlikely.

References

Atrill, P. and McLaney, E. (2006) Accounting and Finance for Non-Specialists, 5th Edition, FT Prentice Hall

Flanagan, B. (2005) ‘Managing Working Capital’. Business Credit, 107 (8), pp.26-30 [Online] Available from: http://proquest.umi.com/pqdweb?did=897512921&Fmt=4&clientId=52650&RQT=30... (Accessed: 3 August 2006)
 

Leff, L. (2003) ‘Cash Flow: The artistry of accounting’. The CPA Journal, 73 (9), pp.16 [Online] Available from: http://proquest.umi.com/pqdweb?did=423246881&Fmt=4&clientId=52650&RQT=30... (Accessed: 3 August 2006)

McClearn, M. (2006) ‘Best Cash Flow’. Canadian Business, 79 (10), pp.145 [Online] Available from: http://proquest.umi.com/pqdweb?did=423246881&Fmt=4&clientId=52650&RQT=30... (Accessed: 3 August 2006)

Silbiger, S. (2005) 10 Day MBA: A Step-by-Step Guide to Mastering the Skills Taught in Top Business Schools. 2nd ed. London: Paitkus Books Ltd