Cash resource management

International Profit Associates on CRM

One of the most common concerns for our clients is the cash position of the business. Somehow there never seems to be enough money to meet their payroll, pay their vendors, and other company obligations on a timely basis, and have something left over. Let’s explore what cash resource management and cash flow really is.

Cash flow basically means “Do I have enough cash in my bank account to cover my expenses?” Sounds stupidly simple, but you’d be surprised at how many people ignore this. “Cash is King” when it comes to the financial management of a growing company. The lag between the time client’s have to pay their suppliers and employees and the time the business collects from their customers is the problem, and the solution is cash resource management. At its simplest, cash resource management means delaying outlays of cash as long as possible while encouraging anyone who owes you money to pay it as rapidly as possible.

When planning the short- or long-term funding requirements of a business, it is more important to forecast the likely cash requirements than to project profitability, etc. While profit, the difference between sales and costs within a specified period, is a vital indicator of the performance of a business, the generation of a profit does not necessarily guarantee its development, or even its survival. Bear in mind that more businesses fail for lack of cash flow than for want of profit.

Sales, costs and, therefore, profits do not necessarily coincide with their associated cash inflows and outflows. While a sale may have been secured and goods delivered, the related payment may be deferred as a result of credit extended to the customer. At the same time, payments must be made to suppliers, staff etc., cash must be invested in rebuilding depleted stocks, new equipment may have to be purchased etc. This lag is often referred to as the cash cycle.

The net result is that cash receipts often lag cash payments and, while profits may be reported, the business may experience a short-term cash shortfall. For this reason it is essential to forecast cash flows as well as project likely profits. To this end, the Senior Business Consultant develops a cash resource management model taking into account all of the in flows and out flows of cash. This computer model is then implemented with the client, and becomes one of the most valuable tools the client has in his/her possession.

The primary purpose of using a cash management forecast is to predict the business’s ability to take in more cash than it pays out. This will give the client some indication of the business’ ability to create the resources necessary for expansion and its ability to support the business owner(s). The cash management forecast can also predict the business’ cash flow gaps — periods when cash outflows exceed the combined cash inflows and the cash reserves. You can take steps to ensure that the gaps are closed, or at least narrowed, if they are predicted early.

So why do small businesses become cash poor? Here are two main reasons:

Companies aren’t realistic when it comes to predicting their income and expenses. They overestimate their income and underestimate their expenses.
Companies don’t see a cash shortage coming and they run out of money by failing to effectively allocate available funds and time that allocation.

You can have the most amazing service or product in the world, but if you run out of cash, it won’t matter.

A cash flow model can be used to compile forecasts, assess possible funding requirements and explore the likely financial consequences of alternative strategies. Used effectively, they can prevent major planning errors, anticipate problems, and identify opportunities to improve cash flow or provide a basis for negotiating short-term funding from a bank or other prospective lenders.

When preparing cash flow projections, be aware of the dangers of:

Overstating sales forecasts
Underestimating costs and delays likely to be encountered
Ignoring historic trends or performances by debtors etc.
Making unduly-optimistic assumptions about the availability of bank loans, credit, grants, equity participation, etc.

These problems typically arise as the result of lack of foresight or knowledge, or because of excessive optimism, and result in under-estimation of the cash and other resources required to sustain or develop the business. There is a domino effect with potentially disastrous consequences.

Once cash flow projections have been prepared, they should be critically examined and used as a management tool to control and improve the expected cash position. Some of the areas that consultants explore with clients to improve cash flow are:

Increase sales (particularly those involving cash or short payment cycles).
Reduce direct and indirect costs and overhead expenses.
Defer discretionary projects which cannot achieve acceptable near-term cash paybacks.
Increase prices and charge interest, especially to slow payers.
Review the payment performances of customers - involve the sales force.
Become more selective about granting credit.
Seek deposits or multiple stage payments.
Reduce the amount of credit given to customers and shorten the time when payment will be due.
Bill as soon as work has been done or order fulfilled.
Improve systems for billing and collection.
Use the 80/20 rule to control inventories, receivables and payables.
Generate regular reports on receivable ratios and aging, and manage them.
Establish and adhere to sound credit practices - train staff.
Use more pro-active collection techniques.
Add late payment charges or fees where possible.
Increase credit from suppliers.
Negotiate extended credit from suppliers.
Make prompt payments only when worthwhile discounts apply.
Reduce inventory levels and improve control over work-in-progress.
Sell off or return obsolete/excess inventory.
Consider utilize factoring, or discount facilities, to accelerate receipts from sales.
Defer non crucial capital expenditures.
Use alternative financing methods, such as leasing, to gain access to the use (but not ownership) of productive assets.
Re-negotiate bank facilities to reduce charges.
Seek to extend debt repayment periods.
Consolidate bank balances.
Sell off surplus assets or make them productive.
Enter into sale and lease-back arrangements for productive assets.
Defer dividend payments.
Raise additional equity.
Convert debt into equity.
Use medium-cash flow forecasts and update them regularly.

The principle reason to incorporate is asset protection. A corporation is a separate legal entity formed under state law. As a separate legal entity, it can conduct business, own property, bring lawsuits and also be sued. An important distinction between the corporation and its shareholders is the shareholders’ liability are generally limited to what they have invested in the company. Their personal assets are separate from the corporation and therefore beyond the reach of potential lawsuits or creditors.

Which raises one question that is sometimes asked, why doesn’t everyone have a corporation if they can protect assets and get other tax benefits?

The first reason is that a corporation must be engaged in a trade or business for the IRS and courts to recognize the benefits and restrictions of being incorporated. Additionally, the principle purpose of forming a corporation is to separate the business’ potential liabilities from the owners’ personal assets. Forming a corporation and putting your personal assets, such as your home, car, etc., does not offer asset protection – all of your eggs are still in one basket.

The specific requirements and restrictions on corporations vary from state to state. However most states have the same general requirements for corporations, and federal courts have issued many rulings over the years that add to the requirements and restrictions on corporations. The general rules relating to corporations include the following:

A corporation must be incorporated in a state, usually by filing articles of incorporation and paying a filing fee to the state. If the business or company has not filed articles of incorporation with the state, then it is not a corporation.
The corporation must issue stock certificates showing who the owner(s) are at the time of incorporation.
A board of directors must be appointed.
Annual meetings of the board of directors or the shareholders must be held and documented.
Books and records must be kept, which includes accounting records as well as administrative filings. Bank accounts must be in the corporation’s name.
Annual reports must be filed with the secretary of state, usually with a filing fee. The annual reports often require information about the officers and directors of the corporation.
If the company is doing business in a state other than the state that it was incorporated in, the corporation must register with the secretary of state as a foreign corporation.
Federal and state (where applicable) tax returns must be filed.

People sometimes believe all they have to do to achieve the protection of a corporation is to hire an attorney and file articles of incorporation. If asked about the corporate books, clients sometimes tell us that they have it “somewhere” but have not seen the book in years. Alternatively, they will tell us that their attorney or CPA prepares the annual report or records the shareholder meetings for them.

There are several problems with expecting your attorney or CPA to do all the paperwork and filings for you. First, the shareholders and directors of the company are the people ultimately responsible for making sure that all filings and documents are maintained properly. This is like mowing grass – either you can do it yourself or you can hire someone else to do it for you. If it is not done, though, things end up in a mess.

What can happen to a corporation that does not file annual reports and pay the fees to the secretary of state? The company can be suspended or dissolved! This means that for legal purposes the corporation no longer exists. If there is a lawsuit or judgment against the corporation, the shareholders’ personal assets would be exposed to risk of loss. The company can lose the right to its own name, which is sometimes the most valuable asset of the company.

Piercing the corporate veil means a court disregards the corporation and looks to the shareholders for personal liability. Courts pierce the corporate veil when the shareholders do not treat the corporation as a separate entity. For example, the shareholder never opens a bank account in the name of the corporation, but just deposits sales receipts and pays bills from their own account. A situation just as severe occurs when the shareholders treat their corporate bank account as their own personal checking account, paying for personal expenses through the corporation. Where the shareholder of a corporation treats the company as an alter ego rather than a separate legal entity, the courts will disregard the corporation and look to the shareholders for personal responsibility.

The shareholders and directors, who are usually the same people in closely held companies, are the people responsible for the corporate formalities. They are the people who will be held accountable by the courts, their creditors and potential litigants.

Article provided by the International Profit Associates tax consulting division.