Cash is king Featured

2:00pm EDT February 22, 2005

The old clich "cash is king" has never been more true. Cash, or liquidity, is the lifeblood of any business. Having a clear understanding of your cash needs and your business's cash cycle is critical to any success.

A cash flow forecast projects operating cash inflow and outflow. As a tool, it allows business owners to determine if there is enough cash generated from operations to meet ongoing obligations. Used properly, it will alert management if and when the business is in need of additional cash infusions.

The surprise factor is something every management team wants to avoid, especially when it comes to liquidity. Realizing one day that your company is about to run out of cash creates a significant challenge.

Business cycles -- and the related timing of cash inflow/outflow -- can and do differ by business and industry. As such, the key to managing cash shortfalls is recognizing the problem as soon as it becomes apparent. Nobody likes surprises, especially if your lending source is a financial institution. Relationships with your bank, or even critical vendors, during cash shortage periods can become strained. The more time your business has to arrange additional financing, the more likely you'll be able to negotiate more favorable arrangements.

Because the actual cash receipts of a business do not necessarily coincide with revenue recognition or profit recognition, a business can experience cash shortages while, at the same time, be showing ongoing accounting profits. Converting sales into cash and making vendor payments and payroll before cash is received can be a delicate balancing act for businesses that face periods of cash shortfalls.

And while not all of these situations have the potential of being business-killers, if a pattern of continually needing cash infusions develops, it can be a warning sign that you need to take alternative measures to resolve the ongoing problems.

When determining your cash flow forecast, ground the assumptions in reality and document them. It is advisable, although not always practical, that the person preparing the forecast be familiar with the operations of the business, including the timing of capital expenditures. Additionally, a critical review should be performed by a second person who has knowledge of the company's business cycle and other factors unique to the company.

There are numerous software programs available to assist in your cash flow forecasts. And once your initial model is built, you can simply build on it for the future. Once the model is constructed, actual results should be compared to the projected amounts.

Variances will exist, and it is incumbent upon management to understand the reasons for them. Not all variations are negative, but it is important to determine if the underlying assumptions need to be modified as your business environment changes.

Some common pitfalls to avoid in your preparations include:

* Excessive optimism as it relates to the top line

* Understated expenses

* Lack of understanding of the timing issues of inflow and outflow

* Failure to consider capital expenditures and debt repayment requirements

* No margin for error

Many companies will prepare a best-case and worst-case scenario of the cash flow projections. This type of forward planning will not go unrewarded, as the company will be in a much stronger position to react to the changing environment.

The lack of liquidity or timely cash flow can result in the business failing regardless of the company's reported profits or losses. The fundamentals are the same in the preparation and use of cash flow forecasting regardless of a company's size.

Obviously, the larger the organization, the more complex the process is likely to be. However, every company can use the forecast in the same way. By implementing the proper disciplines and using cash flow projections as a planning tool, your business will be in a better position to assess and react to the changing business climate and needs of your company.

Sheldon Zimmerman (szimmerman@tbcpa.com) is a principal with Tauber & Balser PC in the Forensic Accounting & Litigation Services Group. With more than 30 years of professional experience, he advises companies on matters relating to mergers and acquisitions, due diligence reviews, accounting irregularities and bankruptcy matters. Reach him at (404) 814-4958.