The GL Finance Corner: Cash Flow (Part 2)
As Dan mentioned last week, there are two things to keep in mind when thinking of cash:
- There is a big difference between revenue and actual physical cash generated.
- There are different tools and approaches used for long-term versus short-term cash flow planning.
Long-term cash planning is critical to understanding and, ultimately, funding the liquidity needs of any emerging growth business. However, long-term cash planning is also necessary for mature companies that are anticipating large capital expenditures, hiring the next critical salesperson, or preparing for a physical or geographic expansion. Many times mature companies, do well at putting together their Annual Operating Plan, but do not think past the current year. Long-term cash planning starts with putting together a 3–5 year long range plan. This plan helps determine a company’s strategic cash needs and, as a management team, it gives you time to begin building and developing banking and financing relationships needed to achieve your capital needs. Then, build a 12-month cash flow statement based off of (a) the long range plan and (b) your Annual Operating Plan (AOP).
On the flip side, companies fall into the trap of a short-term cash crunch. From funding payroll to the next inventory purchase, your working capital needs can be the difference between solvency and insolvency. If you don’t have your finger on the pulse of your short-term cash needs, a significant working capital need can catch you by surprise. Short-term cash challenges also stem from how quickly a company can convert revenue into cash. In pursuit of driving revenue (aka, getting more sales), we sometimes fall short in our underwriting of customers (aka, assessing whether they will pay and if they will pay on time). There are tools and industry best practices that we will touch on next week to help you plan for and avoid a short-term cash crunch and ironically, it all starts with good accrual accounting and tight accounting policies & procedures.
Next week, we will introduce the specific tools that can improve your short-term cash flow planning. But, before we go, think about your short-term cash cycle. Are you building product or providing a service? Check out the different cash cycles, as illustrated above, and think about how this impacts your working capital needs.
