Accounting and Finance for Your Small Business Second Edition_6

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Accounting and Finance for Your Small Business Second Edition_6 Cash Flow Concerns CHAPTER 4 Housing Administration and the Government National Mortgage Association. These obligations are not guaranteed by the Treasury; however, there is an implied backing of the government. It would be hard to imagine the federal Treasury allowing an agency to fail. Major government-sponsored agencies that issue securities include the federal home loan banks, federal land banks, and the Federal National Mortgage Association. The securities provided by these agencies return a modest yield advantage over treasury securities of the same maturity. These securities have a high degree of mar- ketability and are sold in the secondary market through the same security dealers as the Treasury securities. Banker’s Acceptances Banker’s acceptances are drafts accepted by banks and used in financing foreign and domestic trade. The creditworthiness of banker’s acceptances is judged relative to the bank accepting the draft rather than the drawer. Acceptances generally have maturi- ties of less than 180 days and are of very high quality. They are traded in an over-the-counter market dominated by a few dealers. The rates on banker’s acceptances tend to be slightly higher than rates on Treasury bills of similar maturity. Commercial Paper Commercial paper consists of short-term unsecured promissory notes issued by finance companies and certain industrial concerns. Commercial paper can be purchased either directly or through dealers. Among the companies selling commercial paper on this basis are CIT Financial Corporation, Ford Motor Credit Company, and General Motors Acceptance Corporation. Negotiable Certificates of Deposit Negotiable time certificates of deposit (CDs) are time-certain invest- ments. The CD is evidence of the deposit of funds at a commercial bank for a specified period of time and at a specified rate of inter- est. Money market banks quote rates on CDs that are changed 107 Operating the Business SECTION II periodically in keeping with changes in other money market rates. Yields on CDs are greater than on T-bills but are about the same as on banker’s acceptances and commercial paper. Cash Flows Before dealing with the problem of insufficient cash, we should consider the sources of cash inflow. There are four sources of cash inflow to the business: 1. New investment 2. New debt 3. Sale of fixed assets 4. Operating revenues (including collection of accounts receivable) Each of these sources has important limitations on it. The only source that can be relied on in an ongoing way is operating profits. That is what makes profit planning such an important activity for any business. When the business experiences continued profitable operations, accompanied by a positive cash inflow, it can grow most efficiently. Inflows The inflows, or the receipt of payment from customers for product or services, is the lifeblood of any business. The obvious rule with inflows is to get customers to pay as promptly as possible. For example, many doctors and lawyers now demand payment on receipt of service for routine office visits. It is obvious that the efficiency of cash management improves with the acceleration of customers’ payments. The fast food industry illustrates how, by sticking strictly to a credit card and cash-only busi- ness, an extremely low current ratio can be maintained. In contrast to cash payments, payments by check have an inherent delay asso- ciated with the time it takes for a check to clear the bank. During this period, the funds are not available for use by the business. The objective should be to reduce the delay in receiving payment and 108 Cash Flow Concerns CHAPTER 4 the clearing time necessary for the transfers of funds. In addition to federal legislation concerning maximum times for banks to clear checks, several methods have been developed to decrease the float (i.e., the speed of realizing actual cash receipt). • Concentration banking. If your business is large enough to have broad market coverage, you may consider using banks at vari- ous locations within your market areas to speed the clearance of checks. Using banks in areas where sales occur allows for the processing of local checks. These generally clear faster, and funds can be more quickly ...