Section 3:

Launching the Business

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Essentials of Entrepreneurship and Small
Business Management
Ninth Edition, Global Edition

Chapter 13
Managing Cash Flow

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Learning Objectives (1 of 2)
1. Explain the importance of cash management to a small
company’s success.
2. Differentiate between cash and profits.
3. Describe the five steps in creating a cash budget.

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Learning Objectives (2 of 2)
4. Describe fundamental principles involved in managing
the “big three” of cash management: accounts
receivable, accounts payable, and inventory.
5. Explain the techniques for avoiding a cash crunch in a
small company.

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The Importance of Cash
• “Everything is about cash – raising it, conserving it,
collecting it.” ~ Guy Kawasaki
• Common cause of business failure: Cash crisis!
• It is possible for a business to earn a profit and still go out
of business by running out of cash.
– Valley of death

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The Valley of Death
Figure 13.1 The Valley of Death

Source: Based on Yoshitaka Osawa and Kumiko Miyazaki, “An Empirical Analysis of the Valley of
Death: Large Scale R&D Project Performance in a Japanese Diversified Company,” Asian Journal of
Technology Innovation, vol. 14, no. 2, 2006, pp. 93–116.

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Cash Management (1 of 2)
• Wasp Barcode survey:
– 42% of the owners of small businesses with 50 or
fewer employees say that managing cash flow is the
top business problem they face
• Startup Founder Data survey:
– 75% of start-up founders report cash flow concerns as
their top challenge

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Small Business Owner’s Rating of their
Companies’ Cash Flow
Figure 13.2 Small Business Owners’ Ratings of Their
Companies’ Cash Flow

Source: Based on data from Wells Fargo Small Business Index, 3rd Quarter, 2017, pp. 12–13.

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Cash Management (2 of 2)
• Cash management:
– The process of forecasting, collecting, disbursing,
investing, and planning for the cash a company needs
to operate smoothly.
• Young and growing companies are “cash sponges.”
• Know your company’s cash flow cycle.

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Signs of an Impending Cash Flow Crisis (1 of 2)
• Excess supplies of inventory
• Large stock of “old” inventory items that never sold
• Significant volume of fixed asset purchases, such as
machinery and equipment
• Accounts receivable that are past due and growing
• Failing to take advantage of cash discounts from vendors
and suppliers
• Late payments to vendors and suppliers
• Missed quarterly tax payments
• Past-due loan payments
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Signs of an Impending Cash Flow Crisis (2 of 2)
• Above-average interest expense because of excessive business
debt
• Average collection period ratio above the industry median
• Missed sales because popular inventory items are out of stock
• Difficulty meeting payroll on time
• Rapid increase in business expenses
• Rapid increase in accounts receivable balance
• Minimal or no financial controls in place to monitor potential theft
• Infrequent preparation and use of financial statements as a
managerial tool
• Failure to develop cash flow forecasts
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Cash Flow Cycle (1 of 2)
• Cash flow cycle:
– the time lag between paying suppliers for merchandise
or materials and receiving payment from customers

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Cash Flow Cycle (2 of 2)
Figure 13.3 The Cash Flow Cycle

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Cash and Profits
• Cash ≠ profits.
• Profit is the difference between a company’s total revenue
and total expenses.
• Cash is the money that is free and readily available to use.
• Cash flow measures a company’s liquidity and its ability to
pay it bills.

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The Cash Budget
• Cash budget:
– A “cash map” that shows the amount and the timing of
a firm's cash receipts and cash disbursements over
time.
• Predicts the amount of cash a company will need to
operate smoothly.
• Helps to visualize a company’s cash receipts and cash
disbursements and the resulting cash balance.

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Cash Flow
Figure 13.5 Cash Flow

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Preparing a Cash Budget
Five steps:
1. Determining an adequate minimum balance.
2. Forecasting sales.
3. Forecasting cash receipts.
4. Forecasting cash disbursements.
5. Estimating the end-of-the-month cash balance.

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Determine an Adequate Minimum Cash
Balance
• Step 1
– The most reliable method of deciding the right
minimum cash balance is based on past experience.

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Forecast Sales (1 of 2)
• Step 2
– The heart of the cash budget.
– Sales are ultimately transformed into cash receipts and
cash disbursements.
– Cash forecast is only as accurate as the sales forecast
from which it is derived.

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Forecast Sales (2 of 2)
• “Lumpy” or seasonal sales patterns are common.
– 15% to 18% of wine and spirits shops’ annual sales
occur between December 15 and 31.
– 40% of toy sales take place in last 6 weeks of the year.
• Prepare three sales forecasts:
– Pessimistic
– Optimistic
– Most Likely

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Sales Forecast for a Start-Up
Example:
Number of cars in trading zone 84,000 autos
× Percent of imports × 24 %
= Number of imported cars in trading zone 20,160 imports
Number of imports in trading zone 20,160 imports
× Average expenditure on repairs and maintenance × $485
= Total import repair sales potential $9,777,600
Total import repair sales potential $9,777,600
× Estimated share of the market × 9.9%
= Sales estimate $967,982

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Forecast Cash Receipts
• Step 3
– Record all cash receipts when the cash is actually
received (i.e. the cash method of accounting).
– Determine the collection pattern for credit sales; then
add cash sales.
– Monitor closely: Slow and non-payers.

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Probability of Collecting Accounts
Receivable
Figure 13.6 Probability of Collecting Accounts Receivable

Source: Based on data from the Commercial Agency Section, Commercial Law League of America, 2011.

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Forecast Cash Disbursements
• Step 4
– Record disbursements when you expect to make them.
– Start with those disbursements that are fixed amounts
due on certain dates.
– Review the business checkbook to ensure accurate
estimates.
– Add a cushion to the estimate to account for “Murphy’s
Law.”
– Don’t know where to begin? Try making a daily list of
the items that generate cash and those that consume it.

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Estimate End-of-Month Balance
• Step 5
– Take Beginning Cash Balance ...
– Add Cash Receipts ...
– Subtract Cash Disbursements
– Result Is Cash Surplus or Cash Shortage (Repay or
Borrow?)

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Benefits of Cash Management (1 of 2)
• Increase amount and speed of cash flowing into the
company
• Reduce the amount and speed of cash flowing out
• Make the most efficient use of available cash
• Take advantage of money-saving opportunities such as
cash discounts

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Benefits of Cash Management (2 of 2)
• Finance seasonal business needs
• Develop a sound borrowing and repayment program
• Impress lenders and investors
• Provide funds for expansion
• Plan for investing surplus cash

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The “Big Three” of Cash Management
• Big Three:
1. Accounts receivable
2. Accounts payable
3. Inventory
• The Big Three interact to create a company’s cash
conversion cycle:
– The length of time required to convert inventory and
accounts payable into sales and accounts receivable
and finally back into cash.

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Cash Conversion Cycle
Figure 13.7 Cash Conversion Cycle for the Typical Small
Business

Source: Based on data from “2016 Annual Working Capital Opportunity—Corporation Size,” PwC, 2016,
www.pwc.com/gx/en/services/advisory/deals/business-recoveryrestructuring/working-capitalopportunity/size.html.

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Accounts Receivable
• About 90% of industrial and wholesale sales are on credit,
and 40% of retail sales are on account.
• Dun & Bradstreet: only 13% of large U.S. companies pay
invoices by the due date.
• Remember: “A sale is not a sale until you collect the
money.”
• Accounts receivable goal: Collect your company’s cash as
fast as you can.

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Establish a Credit and Collection Policy
• Screen credit customers carefully.
• Establish a firm credit-granting policy.
• Send invoices promptly.
– Cycle billing
• When an account becomes overdue, take action
immediately.

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Accelerating Accounts Receivable
• Ensure that invoices are accurate and timely.
• Include a description of the goods or services purchased.
• Ensure that invoices match purchase orders or contracts.
• Highlight the balance dues and due date.
• Include contact information in case customers have
questions.
• Use a security agreement.

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Accounts Payable
• Stretch out payment times as long as possible without
damaging your credit rating.
• Verify all invoices before paying them.
• Negotiate the best possible terms with your suppliers.
• Be honest with creditors; avoid the “the check is in the
mail” syndrome.
• Schedule controllable cash disbursements to come due at
different times.

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Accounts Payable Patterns
Figure 13.8 Accounts Payable Pattern Among Businesses
by Size of Company

Source: Based on data from Payment Study 2016, Dun & Bradstreet, 2016, p. 44.
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Inventory
• Monitor inventory closely; it can drain a company’s cash.
• Avoid inventory “overbuying.”
– It ties up valuable cash at a zero rate of return.
• Arrange for inventory deliveries at the latest possible date.
• Take advantage of discounts:
– Quantity discounts
– Cash discounts

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A Cash Discount
Figure 13.10 A Cash Discount

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Cost of Forgoing Cash Discounts
Table 13.8 Cost of Forgoing Cash Discounts
Cash Discount Terms Cost of Forgoing the Cash
Discount (Annually)
2/10, net 30 37.25%
2/10, net 40 24.83%
3/10, net 30 56.44%
3/10, net 40 37.63%

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Avoiding the Cash Crunch (1 of 4)
• Barter
– Consider bartering, exchanging goods and services for
other goods and services, to conserve cash.
 More than 500 barter exchanges operate across the
United States.

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Avoiding the Cash Crunch (2 of 4)
• Trim overhead costs:
– Ask for discounts and “freebies”
– Conduct periodic expense audits
– Lease rather than buy
 Operating lease
 Capital lease
– Avoid nonessential cash outlays
– Buy used or reconditioned equipment
– Hire part-time employees and freelancers

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Avoiding the Cash Crunch (3 of 4)
• Outsource
• Use e-mail rather than mail
• Use credit cards for small purchases
• Negotiate fixed loan payments to coincide with your
company’s cash flow
• Establish an internal security and control system
• Develop a system to battle check fraud
• Change shipping terms

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Avoiding the Cash Crunch (4 of 4)
• Start selling gift cards
• Switch to zero-based budgeting
• Be on the lookout for employee theft
• Keep your business plan current
• Build a cash cushion
• Invest surplus cash
– Money market account
– Zero-balance account

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Conclusion
• “Cash is King”
• Cash and profits are not the same.
• Entrepreneurial success means operating a company “lean
and mean.”
– Trim wasteful expenditures.
– Invest surplus funds.
– Plan and manage cash flow.

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Copyright

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