This essay covers important topics related to the management of cash flow within companies. Cash is defined as currency in corporate accounts, short term investments or commercial paper that's easily convertible to cash. A steady cash flow enables a business to pay its employees and vendors and to invest in new projects and opportunities. Companies face many risks associated with running out of cash; without a ready supply of cash, businesses cannot repay loans, provide goods and services to customers or invest in future growth opportunities. Businesses are required to file a statement of cash flow as outlined by the Financial Accounting Standard's Board Statement of Cash Flow (FASB statement 95). Trends in cash management are evolving to meet the opportunities offered by global markets and to mitigate risks associated with cash shortfalls. Emerging topics in cash management include more active methods of forecasting company cash flow. Other factors that will impact cash management forecasting include: Improved technology, centralization of corporate forecasting, tighter regulatory controls, and new statistical techniques for cash flow analysis.
Keywords Cash Flow Statement; Cash Management Forecasting; Cash; FABS Statement 95; Financing Cash Flow; Free Cash Flow (FCF); Internal Rate of Return (IRR); Investment Cash Flow; Net Present Value; Operation Cash Flow; Present Value; Regression Analysis
Finance: Cash Flow
Without the proper accounting of cash flow intake and outflow over time, businesses would be operating at great risk of coming up short on liquid capital. Having a tally of cash on-hand, what's coming in (accounts receivable) and what's going out (accounts payable), allows a business to meet expenses and plan future operations. Depending upon the size and complexity of the business operation, a firm is likely to want to project future cash flow in the short-term (12 months) or long-term (5-10 years). Small business with limited access to credit may find that they must forecast cash flow needs for a number of weeks or months. In all cases, cash flow management requires planning and projections into the future and should take into account reasonable risks that might cause a company to fall short of cash.
History of Business Cash Flow Reporting
Originally, businesses were required to file a statement of changes in financial position, or a funds statement. In 1961, Accounting Research Study No. 2, sponsored by the American Institute of Certified Public Accountants (AICPA), recommended that a funds statement be included with the income statement and balance sheet in annual reports to shareholders.
By 1963, the Accounting Principles Board (APB) had issued its Opinion No. 3 as a guideline to help with preparation of the funds statement. While the funds statement was not mandatory for many, businesses saw its value and began to use it regularly. In 1971, Opinion No. 19 (Reporting Changes in Financial Position), also issued by the APB designated the funds statement as one of the three primary financial documents required in annual reports to shareholders. The APB also said a funds statement must be covered by the auditor's report, but did not specify a particular format for the funds statement.
That flexibility came to an end in late 1987, with the Financial Accounting Standards Board's (FASB) issuance of Statement No. 95, which called for a statement of cash flows to replace the more general funds statement. Additionally, the FASB, in an effort to help investors and creditors better predict future cash flow, specified a universal statement format that highlighted cash flow from operating, investing, and financing activities. This format is still used today (Managing Your Cash Flow, 2005).
Cash flow statements provide essential information to company owners, shareholders and investors and provide an overview of the status of cash flow at a given point in time. Cash flow management is an ongoing process that ties the forecasting of cash flow to strategic goals and objectives of an organization.
This article outlines some of the most common strategies, challenges and issues related to managing cash flow. Issues and challenges include: Maintaining good customer and vendor relations while managing accounts payable and receivable, and paying close attention to the time lag between cash inflows and outflows.
The newest trends in cash management forecasting are also covered in detail. Current methods of forecasting cash flow typically involve the use of regression techniques which don't take into account many business operational variables. This essay details some of the current trends in cash flow forecasting that involve improved computer applications, new statistical methods, the centralization of the forecasting function and other significant developments.
FASB Statement 95
FASB Statement 95 Statement of Cash Flows governs the format of a business's reporting of cash flow. Statement 95 encourages enterprises to report cash flows from operating activities directly by showing major classes of operating cash receipts and payments (the direct method). Enterprises that choose not to show operating cash receipts and payments are required to report the same amount of net cash flow from operating activities indirectly by adjusting net income to reconcile it to net cash flow from operating activities (the indirect or reconciliation method) (FASB, 2007).
The following are cash flow measurements required by the FASB:
- Cash Flow Statements: The cash flow statement acts as a kind of corporate checkbook that reconciles the other two statements. Simply put, the cash flow statement records the company's cash transactions (the inflows and outflows) during the given period.
- Cash Flow from Operating Expenses: Measures the cash used or provided by a company's normal operations. It shows the company's ability to generate consistently positive cash flow from operations. Think of "normal operations" as the core business of the company.
- Cash Flows from Investing Activities: Lists all the cash used or provided by the purchase and sales of income-producing assets.
- Cash Flows from Financing Activities: Measures the flow of cash between a firm and its owners and creditors. Negative numbers can mean the company is servicing debt but can also mean the company is making dividend payments and stock repurchases (Essentials of Cash Flow, 2005).
Cash flow from investment and financing activities are fairly straightforward as outlined by Statement 95. However, Statement 95 allows businesses to report using one of two different methods when it comes to reporting cash flows generated or consumed by operations: The direct method and the indirect method.
- The direct method reports inflows of cash (e.g., from sales) and cash outflows for payment of expenses (e.g., purchases of inventory).
- The indirect method which begins with the net income number, a mixture of cash (e.g., cash proceeds from sales) and non-cash components (e.g., depreciation) and removes non-cash or accrual items, then adjusts for the cash effects of transactions not yet reflected in the income statement (e.g., cash payments for inventory not yet sold).
However, only the direct method reports actual sources and amounts of cash inflows and outflows; the information investors need to understand to evaluate the liquidity, solvency, and long-term viability of a company.
Although the standards generally allow managers to select either method for reporting cash flows, the overwhelming majority have chosen to use the indirect method; the approach that provides the least useful information for investment decisions (Direct- versus Indirect-Method Reporting for Cash Flows, 2007).
Current Challenges to Companies Managing Cash Flow
According to Brian Hamilton, CEO of Sageworks, "Businesses don't fail because they are unprofitable; they fail because they get crushed on the accounts receivable side" (Feldman, 2005).
Companies that run short on cash have to use credit cards or lines of credit to fund operations and pay bills. Lack of cash can cause damage to relationships with vendors and banks result in missed market opportunities, and an overall hit to a company's reputation. Running short of cash can result from poor forecasting, unforeseen risks and poor internal management of cash flow. One of the biggest reasons that businesses run short on cash has to do with unrealistic expectations about how quickly cash will come in the door.
Companies need to be realistic about the length of time it will take to get paid — if one assumes payment in 30 days and it takes 60 days to get the cash, then adjustments to "cash in hand" figures need to be made. Corporations are becoming slower to pay vendors; companies want to make more of their cash which means that they are holding on to it longer. Many businesses are also revising their payables to 45-60 days instead of the previous standard of 30 days (Feldman, 2005).
The lag between the time you have to pay suppliers and employees and the time you collect from customers is the problem. The solution is cash flow management and the idea is to delay outlays of cash as long as possible, while encouraging those who owe you to pay quickly.
Creating a cash flow projection is a preemptive action that is meant to alert a business owner or management to the possibility of a cash crunch before it strikes. Projecting cash flow is not a difficult undertaking, but it does require that accurate and timely information regarding payables and receivables be documented. The following information needs to be considered:
- Customer payment history;
- Assessment of upcoming expenditures;...
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