Cash
Cash or money is an important resource in every business. A farming enterprise will not be able to function sustainably without a continuous flow of cash into the business. Consequently, effective cash flow management is essential to the survival of the business. It is maybe even more important than producing goods or services or generating a sale. However, miscalculate the availability of cash when needed, for example, for payroll or taxes or a critical vendor, and the company may very suddenly be out of business. The company needs cash to pay its bills – business expenses (i.e., service or manufacturing costs, selling expenses, general and administrative costs) – and to pay off scheduled liabilities (e.g., loans, accounts payable, taxes, and so on) on time. Cash comes from only four generic sources:
- Sale of equity. In the form of company stock or ownership of the business.
- Borrowing from a variety of sources such as financial institutions, friends and relatives, customers, vendors, or owners
- Conversion of assets to cash. Sale of idle or unneeded facilities or equipment, reduction of excess inventory, or collection of accounts receivable
- Reinvesting profits. Those resulting from real cash collections, not just from recorded sales that may or may not be collected.
Keep in mind that every business has to be continuously in the cash conversion and expansion business. The process starts with a cash infusion, produces products or services for customers, sells and delivers the product or service, bills, collects payment, and adds the resulting cash to the business coffers. A successful business collects more cash from customers than it expends for providing and servicing its products and services. When the business ultimately liquidates, profit and cash are the same. But during its existence, the business calculates periodic income statements and balance sheets, based on accrual accounting, that serves as a measure of performance. It also calculates a cash flow statement to measure sources and uses of actual cash.
Because of timing differences, profits and cash flow move differently. Good cash flow with inadequate profits means short-term survival but long-term problems. Good profits without adequate cash flow mean immediate trouble. Even if the company generates a profit, it must be concerned with managing its cash and minimising the gap between cash outflow and cash inflow. This cash gap can be considered the number of days between when it pays for materials and services and when it receives payment for the sale of the product or service. The longer this gap, the more time the company is out of pocket for cash. The cash gap needs to be financed, preferably from prior sales. Otherwise, cash must come from outside sources with the attendant costs of borrowing or equity, which harm profits. The diagram below shows the schematic cash flow of a business.
The following diagram is to aid in simplifying the cash flow management process.
Illustration of the cash flow management process.
Cash Flow Process
Any business – manufacturing, service, financial, not-for-profit, government, farming enterprise, and so on – begins with an infusion of cash. The fundamental operating cash flow process within the business then operates in a continuous loop of short-term asset transformation. Several service businesses flow the same pattern, while another enterprise might adjust here and there. For example, A retail store will purchase inventory, but will not do any manufacturing; instead, it will incur merchandising costs to make the items available for sale in an appealing manner.
A business starts with cash – the owner’s investment and usually some borrowed funds. The purchase of goods or services, together with the manufacturing activities or service provision, transforms the cash into inventory or services to be delivered. As the goods or services are provided to the customer, they are converted to accounts receivable or cash receipts. The collection process then transforms the accounts receivable back into cash. If the business process works properly, the cash received is greater than the cash laid out, and the resulting excess provides the business with additional funds to reinvest and grow. The process then needs to repeat itself in an ever-increasing continuous cycle.
Illustration of the cash flow process.
Factors such as accounts payable, outside financing, asset conversion, and profits from operations typically increase the number of cash resources available. However, accounts receivable increases, inventory investment, debt repayments, dividends, and operating losses decrease the level of cash. In addition, most businesses require periodic purchases of property, plant, and equipment to maintain or expand their business activities. These are not part of the cash generation cycle but do require an additional outlay of cash, often quite significant. However, in reality, the cash flow process does not operate in a simple and smooth process, but it is subjected to several disruptions.
The problems associated with too little cash are obvious. But is it possible to have too much cash? At first glance, it would seem not. But having too much cash on hand means that the company is not utilising its cash most effectively. Cash in the form of money on hand cannot generate the kind of potential return required of a business. The cash needs to be invested appropriately in the business to generate an adequate return. If the business can generate a greater return on its cash than it can get from the business, there is a problem with that business. Except in unusual and generally short-term instances, returns on cash will be less than can be generated in a flourishing business. Therefore, having too much cash on hand represents an inefficient utilisation of resources and a flawed investment strategy.
What, then, are we saying? Too little cash means problems of survival, while too much cash can result in lost opportunities and inefficient utilisation of limited resources. Cash flow management is a continual effort to smooth out fluctuations and focus on the Goldilocks Cash Management Principle: “Not too much; not too little, but just the right amount.” What, however, is the right amount? There is no formula to make this determination, but there are several factors that need to be considered:
- There needs to be enough cash to pay the company bills.
- There needs to be enough cash to meet any requirements such as compensating balances, and minimum cash balances to cover service charges or loan covenants.
- There needs to be enough cash to handle unanticipated opportunities or emergencies.
- There needs to be enough cash to provide the owners of the company, company management, and/or the cash manager with sufficient “sleep insurance” – that is, to provide a sufficient margin to meet the safety needs of the business and its management personnel.
Cash Flow Budget
The cash flow budget indicates a negative balance. A cash flow budget will indicate the expected flow of cash, reflects projected figures, shows the amount of money available (bank balance) and will assist the farmer to plan for periods of negative cash flow during the term of operation.
Example of a cash flow budget.
| Month 1 | Month 2 | Month 3 | |
| Beginning cash balance (Opening balance) | -R150,000 | -R26,600 | R212,400 |
| Cash In Flows (Income) | |||
| Livestock sales | R300,000 | R400,000 | R0 |
| Insurance received on product loss | R40,000 | R50,000 | R0 |
| Sales of crops | R150,000 | R200,000 | R300,000 |
| Other | R20,000 | R30,000 | R50,000 |
| Total Cash in | R510,000 | R680,000 | R350,000 |
| AVAILABLE CASH | R360,000 | R653,400 | R562,400 |
| Cash Out Flow Expenses | |||
| Casual labour | R102,800 | R120,000 | R200,000 |
| Feed | R71,800 | R80,000 | R100,000 |
| Seed and plants | R40,000 | R50,000 | R60,000 |
| Pesticides and herbicides | R20,000 | R25,000 | R30,000 |
| Transport | R15,000 | R20,000 | R25,000 |
| Other (Fixed costs) | R40,000 | R40,000 | R40,000 |
| Sub-total | R289,600 | R335,000 | R455,000 |
| Other Cash Out Flows | |||
| Capital purchases | R12,000 | R24,000 | R12,000 |
| Interest paid | R30,000 | R27,000 | R28,000 |
| Rent and shared crop paid | R25,000 | R25,000 | R25,000 |
| Hired management | R10,000 | R10,000 | R10,000 |
| Owners draw | R20,000 | R20,000 | R20,000 |
| Sub-total | R97,000 | R106,000 | R95,000 |
| Total cash out | R386,600 | R441,000 | R550,000 |
| Ending cash balance (Closing balance) | -R26,600 | R212,400 | R12,400 |
Cash Management
A. Objectives of Cash Management
Cash management focuses on making the asset transformation process of the business work smoothly. To accomplish this, the company needs to be aware of the objectives of cash management:
- Control and track cash flows.
- Optimise sources and uses of cash.
- Maximise revenues and minimise expenditures.
- Collect for sales as quickly as possible.
- Expend cash only where necessary (i.e., for value-added functions and activities only).
- Pay creditors no sooner than necessary, and minimise the costs associated with vendor purchases and payments.
- Provide adequate external sources of funding.
- Properly manage external short-term borrowing and/or investment activities.
- Effectively utilise any excess differential cash generated.
- Keep the cash conversion gap at a minimum.
Effective cash management is necessary due to a lack of synchronisation between incoming and outgoing cash flows, a lack of reliable forecast ability of cash inflow amounts and timing, and costs of holding cash balances or borrowing to cover cash shortfalls. What the cash management system should be designed to do is shorten the cash generation cycle by effectively managing the assets, liabilities, revenues, and costs of the business.
B. Maximising Cash Flow, Minimising Borrowing Minimised, and Enhancing Return on Assets
Cash flow can be maximised, borrowing minimised, and return on assets enhanced by:
- Selling profitable products or services to quality customers who pay on time.
- Speeding collection of accounts receivable or collecting in advance of or at the time of delivery of the product or service.
- Getting material and purchased parts inventory into production and out the door as quickly as possible or getting out of that inventory business entirely by letting suppliers carry the inventory.
- Maintaining work-in-process inventory at minimum levels by effective production scheduling and control techniques that ensure the maximisation of real customer orders into production, minimising production time, eliminating rework and rejects, and minimising production costs.
- Reducing or eliminating finished goods inventory by shipping immediately from production to the customer.
- Reducing expenditures wherever possible.
- Taking maximum advantage of accounts payable or other interest-free loans by not paying sooner than required.
- Avoiding accounts payable entirely where payable costs exceed the amount of the invoice or where vendor price reductions for fast payment exceed the cost of processing the payments.
- Operating the business efficiently by keeping costs and non-value-added activities to a minimum Managing the cash of the business by minimising investment in facilities and equipment, or by increasing results with the use of fewer such resources.
- Operating with the smallest number of personnel possible.
- Diligent management of the cash assets of the business by incurring costs and expenses for only necessary value-added functions and activities.
- Maximising sales to real quality customers, which can be produced and delivered at real cash profits.