Profit is necessary but cash remains king
Considerations for cash management
It is very common for management teams to become fixated on profitability. After all, EBITDA is a key metric for investors, banks, and potential buyers to determine the value of a company. Managers in a well-managed company understand how their actions affect the bottom line. The often-overlooked issue is how their actions will affect cash flow.
Even a profitable company can experience cash issues ranging from, pushing out accounts payable for a short period, to the more critical, missing payrolls or loan payments.
The first step in solving a problem is knowing that the problem exists. A simple cash flow statement incorporates income statement and balance sheet information that can alert management to cash flow issues before they become critical.
With regards to operating expenses, look for rising expenses especially in:
- Production supplies
With regards to assets and liabilities, look for increasing:
- Accounts receivable
- Fixed assets
- Prepaid expenses
- Accounts payable
- Current liabilities
If you have a line of credit with your bank, be sure to monitor balances and available borrowings. Extreme movements or sustaining trends in these accounts are warning signs of potential cash issues.
We always want to be in control of cash and never let cash take control of us.
Understanding the order to cash cycle gives management a better understanding of the impact their actions can have on cash flow. The order to cash cycle considers total days and cash expenditures from the receipt of an order to when the cash will be collected from the customer.
A good order to cash cycle will consider:
- When material is delivered after purchase order placement
- When material must be paid for
- How long the product will be in production
- The payroll implications of the production cycle
- Timing differentials between product shipment and shipment invoicing
- The average days for a customer to pay
The order to cash cycle clearly shows that cash flow is more than an accounting or financial issue; it is a supply chain, operations, and sales issue. Made to stock manufacturers must pay special attention to the order to cash cycle as it begins even before an order is received and is sensitive to sales forecasting. In an environment where sales are increasing, the order to cash cycle can predict the impact of increasing cash needs.