Many businesses view cash as king, but the goal is not simply to accumulate and sit on a pile of cash. Instead, an organization should determine how to effectively manage the liquidity/treasury and cash management functions of its business.
There are simple steps you can take to make sure that everyone in your company keeps their eye on maximizing cash flow, says Ian M. Waller, CPA, CIA, a partner at Nichols, Cauley & Associates.
“The goal is to build a lean company culture,” says Waller. “This framework is not a static event. Instead, it is an ongoing process of management to create a culture in which procedures, practices and incentives are aligned to focus on the theme of cash as king.”
Smart Business spoke with Waller about using liquidity and cash management to place your company in the best possible position.
How can an organization take an effective approach to cash?
The process of effective cash management includes selling to gain revenue, paying your expenses, collecting revenue, servicing debt, making a profit and returning money to investors. But the focus isn’t just on the money. To make sure that you’re not just sitting on cash, you need to implement a culture that includes effective policies, procedures and practices to use that cash to your business’s benefit.
What is the significance of liquidity?
Liquidity is critical, as it provides the means to send cash out, make payments to suppliers, make payroll, do owner distributions, pay taxes and other charges, meet debt service obligations, and make payments to investors.
To ensure that a business is able to meet cash obligations as they become due, it needs to measure its cash flow, manage it, predict it and have a contingency plan to ensure that it can meet its obligations. There are many ways that a business can derive liquidity, including taking cash in, cash from customers, debt financing, equity and selling or converting operating assets.
How can a business measure and monitor liquidity?
An organization should do a rolling analysis of its operations. Look at operating sources, operating uses, financing, nonoperating sources and nonoperating uses. This can help you identify areas that might present a challenge to the business. Having systems in place to identify challenges allows you to react early to address issues before they grow into obstacles that you may not be able to overcome.
Key areas that should be assessed include cash level, accounts receivable, number of days sales are outstanding, outstanding line of credit balance, line of credit availability — which should be tested periodically to ensure it remains available — accounts payable due in both 15 days and 30 days, and level of inventory.
Liquidity is hardest to get when you need it the most, so it’s critical that a business develop a contingency plan and periodically review it to ensure that it continues to meet the needs of the company. The contingency plan should address short-term debt, short-term equity, the restructuring of debt, deferring cash outflow and the deferral of certain activities.
By being highly aware of your liquidity situation and planning ahead, you will be prepared to act in a crunch to address debt and equity, putting you in a position to react and restructure.
What are some best practices to ensure the maximum benefits from liquidity?
First, it is vital that you manage and understand your liquidity position. Without that understanding, it will be difficult to properly address the issues. This means you monitor and understand the sources and uses of cash, bill and invoice frequently, bill retainers, use remote deposit capture and lockbox payments systems, and make deposits daily.
To further facilitate liquidity, compensate your sales personnel on collections after returns and allowance, offer a higher commission on higher-margin products and evaluate your vendor payment terms.
How is cash management different from liquidity?
Cash management is the ability to effectively manage the liquidity/treasury/cash flow process of your organization. It is a business management function that focuses on effective cash utilization to provide for an efficient, value-creation, investment-focused organization and should be an integral part of your business plan.
Best practices for cash management overlap those of liquidity in some areas: Use zero-based budgeting, establish a collections policy, monitor customer activity, craft effective sales contracts, invoice in a timely manner, make deposits quickly and use remote deposit capture. In addition, address your vendor structure, evaluate your personnel practices and make sure you have an effective accounting function in the areas of personnel, books closed in a timely manner and variance analysis.
Finally, evaluate incentive payment terms from customers, pay vendors when bills are due and negotiate for the best terms in your business functions.
How can a business determine the right debt to equity mix?
This can be difficult to determine, and a business must consider many factors. Look at the initial source of funding, the debt collateral and the return to investors. When determining whether to use debt or equity, consider the consequences of both long- and short-term financing. Once you’ve determine the best source of funding, use a dashboard worksheet to report and measure results.
Keeping a careful eye on liquidity and cash management practices puts your company in a position to collect on invoices in a timely manner and pay out as money is due.
Ian M. Waller, CPA, CIA, is a partner at Nichols, Cauley & Associates. Reach him at [email protected] or (404) 425-5316.
