5 reasons for cash flow management and planning

Profit is vanity; cash is sanity

In other words, running out of cash from operations or reserves means an inability to pay suppliers for goods and services required to keep the business running. While profits can be accounted for in many ways, some more creative than others, it is impossible to misinterpret what is held at the bank or in cold, hard cash.

Cash flow is the critical engine that drives an organization's operations and growth. It is true that when cash runs out, a business can continue to exist purely on credit or other forms of lending, such as shareholder equity injections or director loans.

However, these inflows are not sustainable because they will stop when the risk of default (non-payment) becomes unacceptable to the lender or when the risk of losing capital investment becomes too high for equity owners.

An organization cannot use profit to trade; it uses cash. Therefore, like any other asset, cash needs to be appropriately managed and planned for. There are several reasons why organizations must pay close attention to their cash flow management and cash flow planning practices.

Yet the ultimate consequence of neglecting them is business failure and, in its most extreme form, a business ceasing to exist.

Click to read Streamline operations and increase profitability (Gated)

1. Optimizing cash utilization

Too much cash can be a problem, especially in an environment where the interest rate is negative, very low, or very high. It signals that the organization cannot find any productive use for its cash to help improve future performance.

Without cash flow monitoring, visibility, and insight into cash flow trends, it is impossible to optimize this situation.

Ultimately, this situation will not be allowed to persist since business owners will start to demand more significant cash disbursements such as increased dividends, share buybacks, or debt repayments.

Being involved in the corporate financial strategy process, FP&A can provide valuable support. Robust cash flow in financial management can help keep track of the day-to-day operations.

2. Funding short-term operations

Not having enough cash can lead to short-term liquidity issues. In this case, organizations might lose their reputation and damage relationships with suppliers and employees.

For example, an inability to meet payroll commitments will not satisfy staff. Normally, these risks would be managed by the financial management or treasury function, which leads the short-term cash flow forecast process.

FP&A can proactively work with the business and treasury to be aware of action options that can be taken to avoid material liquidity issues. For example, this could be to offer additional incentives to suppliers to accelerate the rate of incoming cash.

3. Meeting medium-term investment requirements

This is important to support the agreed business objectives. The main risk is an organization missing opportunities to meet future performance expectations.

If mismanaged, capital projects may be delayed and, in extreme cases, stopped. FP&A helps ensure a robust capital investment process is in place and a strong link between expenditure timings and the forecast process.

4. Avoiding the need for emergency cash

Emergency cash is likely to harm an organization’s reputation, lead to higher costs through interest payments, and enable financially secure competitors to mount tactical attacks to attract customers or gain market share.

FP&A teams can work with internal and external business stakeholders to ensure a clear communication strategy around the lack of cash in the organization and its potential impact on day-to-day operations. This is especially important for key customers and suppliers, who are most at risk of a competitive attack.

5. Avoid breaching covenants

Many organizations, especially private or small to medium-sized ones, have agreements with external funding institutes that require minimum cash flow levels. Breaching these can lead to severe penalties, including, at the more extreme end, taking control of assets or forcing the sale of assets at a distressed price.

For public companies, such insolvency can impact creditworthiness and make future financing costlier. FP&A teams need to ensure that the management team has full visibility of this risk as early as possible, along with associated contingency planning.

This will allow the office of the CFO to proactively present contingency plans to lenders so that together, they can explore constructive action options in a timely manner.