Cash rules : learn and manage the 7 cash flow drivers for your business success / Bill McGuinness. Bill McGuinness is a passionate apostle of cash-flow management, and he knows what he's talking about.
The ABCs of Cash Flow
This book shows you how to understand, measure and analyze your business, as a whole and in its individual parts, in terms of these cash drivers. Or maybe sales management is your area of expertise and you need to think about the terms of a new sales force compensation plan, one that is given due consideration.
Cash Rules
It focuses on what I call cash drivers, seven things that control virtually all cash flow for virtually every business virtually all the time. Before we take a closer look at those cash drivers, however, we need to have a clear sense of the nature and importance of cash flow itself.
Why Cash Flow Is Important
The overall technical excellence of the vehicle, the handling of the suspension system, the low coefficient. A proportional increase in bank debt or supplier credit may be part of the fuel supply system.
Profitability versus Cashflowability
You might have a better mousetrap to sell, but if your company can't produce enough of its own fuel, it will be left by the side of the road. So, instead of being able to continue, they found themselves pulled far off the road and in danger of falling into the bankruptcy ditch.
Cash Is King
You are very profitable, but in terms of liquidity, your back is against the wall. It's expensive for shareholders and sometimes for management teams themselves, as more cash-flow-sensitive companies take them over and begin the downsizing.
What Is Cash Flow?
It makes sense that understanding cash flow is at the heart of the banker's business. But cash flow and value flow are quite different in several respects.
Team Cash Flow
This doesn't mean you need a company full of accountants, but you do want every key player to clearly see and understand the cash flow issues. Knowledge of cash flow dynamics should be a qualification for virtually any responsible job in your organization.
Plan of the Book
The forecasted values of cash managers are used to teach a method for constructing cash flow statements of forecasted periods. The purpose of this chapter is to think of the business that uses cash drivers as a strategically consistent set of measurable business goals focused on cash flow dynamics.
Cash-Flow Language
There is also a category of investments that can be made into cash almost instantly, such as treasury bills and certificates of deposit. For entire economies as well as for individual firms, there is a relationship between money.
Even so, there are only relatively small percentage changes in the money supply over the course of a typical year. In general, the amount of money and its velocity will have more variation for a smaller business than for a larger one.
Introducing the Cash Drivers
You can get two weeks, or 30 days, or other terms in which the payment must be paid, of course, but when it is due, it must be paid in cash. No one wants to be paid with a stack of receipts, even from your best customers.
A New Language
With the background of our basic liquidity discussions thus far, let's turn to an overview of liquidity drivers. For most of us, most of the time, however, the basic seven cash drivers are the appropriate tools.
Cash Flow in a Company Context
Because of the magnitude of this cumulative cash drain, Jones can recover, but still not a team. And especially in light of the ambitious growth rate in sales that Jones was targeting, professional cash flow planning was a management imperative.
Building a Cash-Flow Culture
Once the cultural shift to cash flow thinking and the cash driver language takes hold, the next step is to set cash flow goals at the level of each major organizational unit or person in the company – and then fully setting cash flow goals. link the objectives to the reward system. Once the cultural shift to cash flow thinking and the cash driver language takes hold, the next step is to set cash flow goals at the level of each major organizational unit or individual in the company – and then fully connecting the cash flow objectives. targets to the compensation system.
Basic Accounting
These two primary financial statements will be scrutinized to develop the important insights resulting from their ratio analysis and cash flow analysis. Once you've mastered these basics of accounting grammar, you'll be ready to focus specifically on each of the seven money drivers (Chapters 5 through 11).
The Grammar of
This overview of basic accounting will make it much easier to understand everything that follows, starting with being able to see that although many transactions will affect your cash account as a debit or credit, many others leave money completely intact. The frequency of each type of transaction, the amounts involved, and the timing of each will affect the degree to which the value flow differs from the cash flow.
Cash-Driver Language
The Accounting Equation
In this case, the balance sheet is still balanced and the error must be found in another way. This, however, gets to a level of detail that we need not concern ourselves with here.). Take a moment to review the structure and content of the balance sheet on page 35.
The Double-Entry System
The profit or loss that the income statement records over the period is transferred to the balance sheet from a specific point at the end of the period. The structure of the financial statement yields only five basic elements: assets, liabilities, and net worth from the balance sheet; and income and expenses from the profit and loss account.
Statements
The cash flow statement integrates the income statement data with the additional information provided by the balance sheets to get the full story. The cash flow statement follows the underlying cash events behind the balance sheets and income statement, the accrual numbers of which show only an as a cash truth.
To prepare a cash flow statement, you need three things: a beginning balance sheet, an ending balance sheet, and an income statement for the time in between. With these statements, you can adjust each main value line item of the income statement through the change in its closest associated balance sheet items to determine what actually happened in cash terms.
Analysis of Ratios
Cash From Sales in the Second Quarter To complete the statement of cash flows, go line by line, recording all changes in the elements of the income statement and balance sheet, showing where the cash came from and how it was used during the reporting period. . The process follows the order of the income statement as if everything was settled in cash, but then immediately reverses the misleading assumption.
The Cash-Adjusted Income Statement
If the net cash income line on the UCA cash flow statement is positive, the answer is yes. The same applies to the net cash from operations lines on the other two cash flow statement formats.
Long-Term Viability & Cash Flow
When approaching lenders, it's always helpful to have information in the form that most directly addresses their concerns. Positive cash flow is also a measure of sustainability in the public sector and non-profit organizations.
Other Measures of
After careful analysis – realistically and substantially isolating the transportation issues from these other higher-level management tasks – the company concluded that it would be a good choice to outsource shipping entirely, rather than lease new trucks or to buy. The current ratio is rooted in the point-in-time values of the balance sheet and thus says nothing about the operational flows.
The Ultimate Cash-Flow Risk: Bankruptcy
Careful management of the seven cash drivers discussed in the following chapters will certainly help a company avoid bankruptcy. Because its calculation includes some of the ratios we just looked at, this is an especially good time to take a closer look at it.
Getting Ready for a Closer Look at the Cash Drivers
This latter part of the increase would show up in a jump in the relative measure of days receivable – the impact of management's decision. Sales growth, gross margin, and operating expenses incorporated most of the key dimensions of the business portion of the income statement.
The Seven Cash Drivers
Clearly, the expansion of the ballpark is the single most important factor affecting cash flow and thus the sum of all expected future cash flows. If we discount all the expected future cash flows back to today, we arrive at the company's present value.
Sales Growth
Tight control over the factors of volatility—receivables, inventories, and liabilities—can make a significant difference to cash flow. Many industries have rule-of-thumb valuation formulas, but such formulas are ultimately approximations of discounted cash flow expectations.
The Dominant Driver
Similarly, the present value of a business is the sum of all future cash flows discounted to the present day. The present value of a business is the sum of all future cash flows discounted to the present day.
Growth That Ripples
Understanding such financial structures will also help free you from the tunnel vision that a preoccupation with your own function can sometimes impose on you. This can help free you from the tunnel vision that a preoccupation with your own function can sometimes impose on you.
Marketing Mix
Judy Nagengast credits cash flow planning and careful balancing of sometimes conflicting goals as a major key to CD's continued success. The company's annual financial plan has as its focal point a liquidity projection prepared by a former banker, which helps the company formulate and quantify its options and trade-offs.
Growth Takes Cash
He demonstrated that the company's combination of rapid growth and mix change plans threatened a cash drain. Because the cash flow and strategic planning around these issues was done early on, the company was able to solve the problem through a combination of very careful timing and presenting a case that convinced lenders that a temporary increase in leverage did not increase their risk of loss considerably.
Breakeven Analysis
And just like most of life, the faster you go, the faster you burn the fuel. However, it can also mean that the faster you go, the less efficiently you burn the fuel.
Sustainable Sales Growth
It is balanced in the sense that the company's growth rate makes it happen. Note that this discussion of sustainable growth implicitly assumes that the only increases in your equity are from profits retained in the business.
Big-Gulp Sales Growth
An understanding of the dynamics of cash flow and a reasonable command of the language of the money manager will help to realize these objectives.
Put another way, the value of the combined company will be the same as the sum of the two companies before the acquisition. It offsets more than the value of the real estate assets you thought gave you such an edge.
Gross Margin: First of the Fundamentals
Your managers should consider applying commission rates or advertising budget percentages against dollars of targeted gross margin instead of against sales volume. And the sales force commission structure is not geared to sales volume at all, but directly to dollars of gross margin.
The Two Sides of Margins
Such improvements require not only an understanding of the impact of the seven cash drivers, but also considerable discipline and time. It may be that a reasonable level of price increase would be generally acceptable in your market without a particular need for elements of the second or third tactic.
Gross Margin & Contribution Margin
If you were only looking at gross margins, you could easily make some bad decisions. It is a mistake to assume that higher gross margins are inherently more profitable without first considering other cost elements.
Refining Gross-Margin Calculations
A key to success here revolves around the availability of the right information at the right time in the right form. Pay attention to the design and use of the reports your accounting, finance, and information technology departments produce.
Distribution Channels & Gross Margin
Internet sales in 1998 totaled about $25 billion, and two-thirds of them were business-to-business. Direct selling is also expanding into business-to-business sales in industries that previously followed less direct channels.
Gross Margin &
Totally Perishable ‘Inventory’
Now let's turn explicitly to operating costs – that is, selling, general and administrative (SG&A) costs – as a cash driver unto itself. SG&A excludes expenses not associated with the operating elements of the business, such as investment, financing and taxes.
SG&A: The Other Fundamental
You have managed to reduce costs by meeting your customers' needs to the lowest level consistent with quality and competitive pressure. In a manufacturing or merchandising business, more of your costs are typically in the cost of goods sold, but SG&A is still very significant and includes all of the company's overhead items: the people and functions, the spaces and resources that are not directly attributable to the actual product.
Cost Ups & Downs
Do not allow costs to increase in your area unless they are materially increasing quality, capacity, sharpness or responsiveness.
SG&A & Capacity
More muscle to begin with reduces both the likelihood and severity of the eventual bad times. For example, unless your computing needs require the latest equipment, a system only a year or two old may be sufficient for your needs and cost a fraction of a new model.
Expense & Expenditure
In business, however, there is almost always a time gap between when an expense is incurred and when you actually set aside the cash—that is, make the expense. AT THIS POINT IN THE SEQUENCE OF DISCUSSION OF THE CASH DRIVER, we have examined the increase in sales, documented its cost through cost of goods sold, and are left with some gross margin from which to pay SG&A expenses.
Swing Factor #1
It is for this reason that accounts receivable (A/R) are first and foremost in the class of cash drivers known as swing factors. By offering customers payment terms other than cash on hand, you automatically make four assumptions: that the customer has both 1) the willingness and 2) the ability to pay you; and that neither 3) skill nor 4) readiness will fail between the time of sending the order and the time of payment. The better you manage your receivables—money owed to you for work completed or products delivered—the less likely you are to get bitten by a bad guess.
Accounts Receivable
This means that there are so many days' sales tied up or invested in receivables. If A/R days move up from one period to the next, you generally know that some kind of management decision or practice has changed with respect to accounts receivable.
Communicating With Customers
This first call is also a good time to confirm that the invoice has gone to the right person at the right address. For example, with Sally and Tom Fegley considering converting their home-made chocolate business into sales through their own stores, they hope to not only improve gross margins, but also resolve some accounts receivable issues.
A/R & the Marketing Connection
Second, Amgen's sales are much more skewed toward the domestic market than its more internationally minded competitors. Even more to the point is the impact these issues could have if and when Amgen transitions to a lake.
Industry Norms
To the extent that a new client's financial statements are available or can be made available, why not apply cash flow thinking to that client's financials as part of the review process. To the extent that a new customer's financial statements are available or can be made available, why not apply cash flow reasoning to that customer's finances as part of the credit review process.
Factoring
Days of inventory is the average number of days worth of production and purchases held in inventory at the end of the period. This is a natural consequence of the statistical inefficiency required to maintain buffer stocks at multiple points along the distribution chain.
Swing Factor #2
But what remains in inventory, by definition, has not yet been sold, so it is valued at cost and related to cost.
Inventory
Thus, the more seasonal a business is, the more important it becomes to forecast, track and manage cash flow at shorter intervals. A good weekly cash flow projection, for example, helps New Covenant Care, a multi-state operator of nursing homes and assisted living centers, plan for routine capital expenditures.
Inventory Valuation
Because of those swings, her use of the bank line of credit bounces around quite a bit. Keeping the bank informed helps, and one of the more important tools for keeping the bankers informed is Susan's weekly cash flow report.
Types of Inventory
Product design and production design can often contribute to improved cash flow by improving the timing of the various steps when an item moves from raw material to finished product. Product design and production design can often contribute to improved cash flow by improving the timing of the various steps when an item moves from raw material to finished product.
Inventory & the Production Process
From an equally narrow production standpoint, there should be only one size and one color, the basic feature mix should be standardized, and there should be one long, continuous production run. As they did at the Williams Oilfield Contracting Co. were, they should be basic tools in the kit of every responsible member of your management team.
Just-in-Time (JIT) Inventory
Each piece of inventory must either be adding value or moving to the next place where value can be added. Everyone and everything in the system must be actively adding value, adding value, or moving towards a value-adding workplace at all times.
Inventory & Purchasing Management
It is all about flow, movement and turnover, in the service of value addition, quality and efficiency. In addition to these obvious costs associated with out-of-stock conditions, there are also hidden costs.
Inventory-Related Costs
Book value is the largest of the three and has several components, the largest of which is the cost of capital. The first thing you'll want to do with the estimates you make for inventory carrying costs is to include them in the economic order quantity calculation formula.
Suppliers & Inventory
Accounts payable is also measured in days, but in days of cost of goods sold, rather than days of sales as with accounts receivable. What we say to our customers from an accounts receivable standpoint is very similar to our position on accounts payable.
Swing Factor #3
Accounts payable is more closely related to inventory, which is valued at cost, while accounts receivable are inherently measured in sales prices that capture what the customer owes you.
Accounts Payable
If you're entering a new product category or expanding into a new market area, your business will likely represent net new volume for a supplier. The same principle of negotiating with good suppliers in advance applies if your business is seasonal.
Discounts
Prioritizing & Policing Payables
In fact, for every cash driver, the question arises of leaving some slack in the system. In the absence of a cash flow statement, you will have to determine the actual capital expenditure yourself by referring to the balance sheets and income statement.
Keeping Up
Publicly traded companies produce cash flow statements that show depreciation and capital expenditures, but many small and medium-sized businesses do not. To calculate net investment, the sum of depreciation and amortization costs is taken from the income statement.
Capital Expenditures
If the net fixed assets have decreased over the period, deduct the amount of the decrease from total depreciation and amortization. Arithmetically, therefore, if net fixed assets decreased by an amount equal to total depreciation and amortization, there were no net capital expenditures during that period—not at all an unusual situation.
Depreciable Life & Economic Shifts
Perhaps the most critical asset-management issue concerns the management of human capital. It is based between the ears of knowledge workers who are highly mobile and have mostly rejected the concept of corporate loyalty.
The Capex Driver & Sales Growth
Investing in the wrong technology or failing to keep up with change can be fatal. Perhaps the most relevant question is, does the calculation cost-effectively advance the company's position relative to competition in the context of its strategic goals.
Depreciation & Capex
For income statement and income tax purposes, we use depreciation expense – a way to recover and allocate the original cost of the asset. This translates into more profit and higher taxes in the later years of the asset's depreciable life.
Leasing & Capex
Capital Budgeting
Depreciation as a tax shield is simply based on the non-cash nature of depreciation expense when calculating cash flows. So, for example, when you calculate the cash flows in and out, resulting from any investment decision, depreciation on a purchased asset never enters the equation because it is not a cash cost.
Capex & Growth
If you look first at efforts to offset some of the effects of the growth cycle, you may find that short-term leasing (that is, operating leases of needed additional assets) is an attractive option. Direct efforts to smooth out the peaks in the growth cycle can also be a fertile field for minimizing the risk of over-investment in additional capacity.
Cash Flow &
Business Management
We'll review cash drivers using an extended and detailed hypothetical case study that illustrates how to influence drivers on an integrated basis as you move your company forward. The result of this integrative thought process will produce a series of possible future values of the cash driver (cash flow sheet - CDSS) that can then be converted into projected cash flow statements to reveal the consequences of money strategies embedded in CDSS Assumptions.
The Mechanics of
Many accountants get so focused on describing exactly what happened, according to generally accepted accounting principles, that they don't focus as much as you might need on the forward view. The forward look is the essence of this and the remaining chapters of this book.
Cash-Driver Shaping
This forward view is often a different perspective than your accountant may be used to providing.
Others may prefer to use their business dynamics as a means to think contextually about the seven cash drivers and then translate them into a projected cash flow statement.
Shaping the Cash Drivers
2,850,000 worth of new equipment to become a low-cost producer in the routine part of the general printing business. The box at the top of the next page shows the completed design sheet.
Projecting Future Cash Flows
This future cash flow projection for the NTTC roll-up can be found on page 178. Next, in terms of the cash flow projection, we need to adjust the expected sales figure for 2001 to find the change in accounts receivable. cash from the sale.
Putting It All Together
Then redo the cash flow statement from Step VII (Financing Cost) to make sure you're not only collecting interest on the additional debt, but also the additional interest expense on that interest. However, there is a reasonable relationship between net cash income and capital expenditure such that one conceptually represents a reasonable "down payment" of the other.
Cash Drivers &
This book is intended to sharpen and clarify your thinking by focusing on cash flow through the seven key drivers that dominate it. Next, you put these thoughts into context with the larger economy in which it all takes place.
Strategic Thinking
Easily recalculate the projected cash flow statement based on a new assumption about any of the cash flow factors. The task of cash flow forecasting can be simplified by temporarily assuming that all or at least most of the other cash flow factors remain constant in relative terms.
Cash-Driver Harmony
The point here is how thinking in terms of the seven money drivers can help organize and focus managers' scenario formulations and thought processes on the key issues of their business. Further, these cash driver choices are sensitive and reflect the entity's most fundamental vital signs - cash flow.
Cash Drivers & Competitive Advantage
The key will always be to maximize cash flow as ROI through your decisions in a competitive context. And how you can avoid a competitive positioning situation where others are getting better returns on investment cash flow than is available to you.
Cash Drivers & Export Potential
The first issue to consider when evaluating export possibilities is the adequacy of your scarcest resource, driving time. Unless you have highly reliable foreign subcontractors or partners for most key areas of the business, you will need to start very slowly, first building your own base of expertise and knowledge before making major commitments to a new market.
Debt & Equity Values
There is another dimension of risk, namely financial risk to the company's financial stakeholders. These are the company's lenders and owners, and the risk to them is the erosion of the market value of the debt and equity they hold.
Risk, Return
While we've already explored much of the subject of risk by looking at the cash drivers, we've done so specifically only in terms of operational risk.
Rather, it is based on the stream of cash earnings that those assets can produce. Rather, it is based on the stream of cash earnings that those assets can produce.
