Accounting and Finance for Your Small Business Second Edition_7

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Accounting and Finance for Your Small Business Second Edition_7 Operating the Business SECTION II adjust to deviations in expected outcome. For example, these and other questions may be asked: • How flexible are expenses? • What can be cut or eliminated? • How quickly can we respond? • How much effort should be devoted to the collection of receiv- ables? • What additional purchases will be required for unexpected increases in business? • Can labor be expanded and at what cost? • Can the current plant handle the additional demand? • How much money will be needed to finance buildup? The answers to these and other questions will show the effi- ciency and flexibility of the business under varying conditions. By relying on numerous budgets with different ranges of possible out- comes, you have the option to consider and be prepared for many more contingencies. Summary Your working capital is principally composed of cash, accounts receivable inventory, accounts payable, and other short-term payables. Cash serves many functions within the business and actually is the medium of exchange for all transactions. The investment of excess or temporarily idle cash should be made with a consideration for the expected yield, the associated risk, the liquidity of the invest- ment, and the transactional costs associated with the exchange of investment with cash. There are many ways to invest excess cash, each of which has a risk-and-return relationship and other condi- tions and constraints. Many of the constraints deal with liquidity and transactional cost considerations. A business selling its product in a large geographic area has to be concerned with the time delays associated with the physical transfers of payment (cash). This delay, or float, costs the business 132 Cash Flow Concerns CHAPTER 4 money. Many methods have been developed to minimize the delay and to speed up the receipt of cash: concentration banking, lockboxes, and others. In addition, you can delay cash outflows in order to earn additional interest. You should have a cash flow budget. Determining how cash flows within the business may best be envisioned as an actual flow of dollars for each transaction. Cash management should consider how things are being done and question all cash expenditures: Can we get along without it? Can we postpone it? Can it be done more cheaply? As with cash, you can profit from managing your accounts receivable. One of the easiest methods of gaining an understanding of how well collections are being made is to establish a frequency distribution of the age of the receivables. It may be more profitable to discontinue sales to delinquent customers than to continue to advance credit, tying up valuable assets. An unpaid account receiv- able is an outstanding loan. The other side is your policy about paying your bills. Another simple tool is a chart showing discounts taken and, more impor- tant, discounts not taken. A common discount, 2/10, N/30, means that it costs you 2 percent of the invoice amount to extend pay- ment for 20 days. This can be equated to a 37 percent per annum interest rate. Discounts lost can have serious cost implications. Timing is all-important in transactions. Many businesses expe- rience cycles that affect their cash status. Planning for these timing variations may allow you to earn more interest during periods of excess cash while having enough cash available in times of poor cash flow to avoid cash borrowing. Appendix: Cash Flow Example In this appendix, we review a typical cash forecasting model that uses a series of assumptions to arrive at a monthly prediction of cash inflow and outflow. The model begins with assumptions regarding sales levels, collection periods, and debt interest rates in the sec- tions entitled “Sheet 1.1” and “Sheet 1.2.” These assumptions are then used to arrive at predicted cash receipts and cash disbursements 133 Operating the Business SECTION II by month, as noted in the sections entitled “Sheet 2.1” and “Sheet 3.1.” We bring this information together in “Sheet 4.1” to arrive at a net cash change per month. The final section, “Sheet 5.1,” notes the am ...