Controlling cash flow for business growth

CIMA is the Chartered Institute of Management Accountants. Its members are trained and qualified in the vital area of management accountancy. Businesses can only compete effectively if they have the best financial information and the best people to make decisions based on that information.

CIMA is the world”s leading and largest professional body of management accountants. Its training means it produces financial managers with the many and varied skills necessary to handle global competition. From its headquarters in London and 11 offices outside the UK, CIMA supports over 172,000 members and students in 168 countries.

The CIMA qualification is recognised internationally as the most relevant financial qualification for business. Many senior managers running global companies are, or are supported, by CIMA-trained accountants. Management accountants are, or advise, key decision makers in businesses. They have a key role in ensuring that businesses are not only competitive, but also financially secure. This means looking to the future and predicting what might happen based on current figures.

This case study looks at how management accountants forecast, monitor and control cash flow in order to maintain the ongoing financial health of businesses.

The importance of cash flow

Cash flow is of vital importance to the health of a business. One saying is: “revenue is vanity, cash flow is sanity, but cash is king”. What this means is that whilst it may look better to have large inflows of revenue from sales, the most important focus for a business is cash flow.

Many businesses may continue to trade in the short- to medium-term even if they are making a loss. This is possible if they can, for example, delay paying creditors and/or have enough money to pay variable costs. However, no business can survive long without enough cash to meet its immediate needs.

Cash inflow and outflow

Cash comes into the business (cash inflows), mostly through sales of goods or services and flows out (cash outflows) to pay for costs such as raw materials, transport, labour, and power. The difference between the two is called the net cash flow. This is either positive or negative. A positive cash flow occurs when a business receives more money than it is spending. This enables it to pay its bills on time.

A negative cash flow means the business is receiving less cash than it is spending. It may struggle to pay immediate bills and need to borrow money to cover the shortfall. The distinction between cash flow and profit is shown in the example. In accounting, negative figures are shown in brackets.

Liquidity

Businesses aim to provide greater financial returns than the level of interest earned by simply placing the cash in a bank. They can also hold too much cash. Cash does not earn anything so holding too much cash could mean potential losses of earnings. The cash situation is referred to as the liquidity position of the business. The closer an asset is to cash, the more ‘liquid’ it is. A deposit account at a bank or stock that can easily be sold are liquid. Assets such as buildings are the least liquid. Liquid assets are those that are most easily turned into cash.

Cash flow is always important, but especially when it is not easy to obtain credit. When the economy is in recession, financial service providers are reluctant to lend money. Borrowing also becomes more expensive as interest rates are raised to partially offset the risk of borrowers not paying back loans.

Controlling cash

Controlling cash is essential and management accountants deal with a range of cash issues:

• ensuring that sufficient cash is available for investment by not tying up cash in stock unnecessarily
• putting procedures in place for chasing up outstanding debts
• controlling different levels of cash outflows in relation to the size of the business.

For example, a car repair garage buys parts and tyres whilst a hairdresser buys shampoos, equipment and pays for power. In each case, if the business has cash problems it may be slow to pay its bills to suppliers. This creates further cash problems which spread throughout the economy. If small suppliers are not paid they may go out of business. This in turn may affect businesses further up the ladder.

The cash flow cycle

CIMA-trained management accountants are involved in all sectors of industry – from government departments to well-known names such as Rolls-Royce and Tesco. Each organisation has to manage and monitor its cash flows carefully. Cash does not just arrive; it must be chased, recorded and managed. At all times, there must be enough cash to pay bills. For a retail business like Tesco, the main cash inflows or receipts will be from sales; the main cash outflows or payments will be for supplies and overheads associated with its stores, such as rents, rates, wages, power or transport.

If there is too much cash in any organisation, it needs to be put to work for instance, in a deposit account or investments where it will earn interest. If there is too little, the business needs to know how much it will have to borrow to cover the shortfall and for how long. Borrowing money also has costs which need to be managed.  Good cash flow management requires good information, professional training and good management decision making. 

CIMA-qualified management accountants learn to forecast flows of cash so that such problems do not arise. A basic cash-flow forecast might look like the example shown. For a business the size of Tesco, the figures are likely to be in millions of pounds.

In this example:

• The opening balance is the amount carried forward from the last period. In January this is £10,000, in February £2,000 and by March is a negative balance of £5,000
• Receipts are inflows from, for example, sales, interest on investments, payment of outstanding customer accounts
• Payments show amounts coming due e.g. rents, tax payments, interest on loans, supplier contracts etc
• Net cash flow shows the cash position forecast for that month. In both January and February, this is negative, so this would ring warning bells.
• The closing balance forms the opening balance for the next period.

Cash flow management is about forecasting these flows and balancing the cash flowing in with that flowing out.

Managing cash flow

Managing cash flow is vital both to the survival of a business and to its long-term well-being. CIMA-qualified management accountants often hold key positions in organisations, such as Finance Director or Financial Manager. Their thorough knowledge of the industry in which the business operates allows them to forecast, monitor and control cash flows using key indicators for that business, such as sales trends. For example, Tesco would expect to sell more just before Christmas and in the January sales. A carpet manufacturer might look how many new houses were being built in the area, whilst an organic farmer could look at how consumer tastes and needs are changing.

Often cash inflows lag behind outflows, so a business may need to borrow or use cash from a previous period to cover the shortfall. For example, a farmer who sells potatoes to Tesco will want paying as soon as the sale takes place. However, Tesco does not receive the cash for these potatoes until they arrive and have been sold in its stores.

Improving cash flow

A business can look for imaginative ways to improve cash flow or manage credit:

• Making better use of assets empty warehouse space or unused transport could be hired to other businesses.
• Make sure as little interest as possible is being paid on borrowing pay debts early if possible and consolidate debts into one long term, low interest rate package.
• Negotiate payment dates with suppliers, perhaps paying later, or in instalments.
• Avoid offering discounts for early payment (an effective but expensive way to get more cash in sooner).

If a business is profitable, this should mean a little more cash comes in each time the cash flow cycle turns. This can then be used to cover those periods where there is a shortfall. Careful management by a trained management accountant will ensure that the business is aware of possible future shortfalls