Content1.Introduction2.Definition2.1Liquidity2.2Cash FlowStatement of cash flow3.Liquidity management4.Cash Flow management5.Cash Accounting and Liquidity Planning6.Case Scenario:7.Conclusions1.Introduction"Cash is king." "Happiness is a positive cash flow." Where does money come from and where does it go?Liquidity is one of the critical success factors for a company; it is integral to running a business. The most important aspects of liquidity are the ability to ensure solvency and generate payment surpluses. Companies constantly try to analyze and plan their cash flow.Surveys are conducted constantly of failed businesses. Most failed businesses, up to 60%, say that all or most of their failure was due to cash flow problems. Businesses have to have as their guide another old saying. Nothing matters more than cash. Making a profit is nice, cash flow is necessary. Cash management is the key to business success.Start-up businesses often find themselves short of cash right off the mark. Existing businesses can find ways to survive if they can find ways to generate cash. Cash is the single most important element of survival for a small business. Small businesses often say that an inability to control cash is their single biggest problem. Unfortunately, established applications such as Accounting or Cash Management don’t provide the necessary information on cash flow required by companies;2.Definition2.1LiquidityYou often hear the word liquidity used in combination with cash management.Liquidity is the ability to fund assets and meet obligations as they come due.Liquidity is the amount an association holds in cash and other assets that are quickly convertible into cash without significant loss.Liquidity is an association’s capacity to meet its financial obligations and commitments at reasonable or acceptable costs.The essence of liquidity is having cash when you need it.In other words, if the firm has adequate liquidity, it can pay its current liabilities such as accounts payable. Usually, accounts payable are debts you owe your suppliers. There are methods you can use to measure your liquidity.Financial ratio analysis will help you determine how liquid your firm is or how successful it will be in meeting its short-term debt obligations. The current ratio will help you determine the ratio of your current assets to your current liabilities.Current assets include cash, accounts receivable, inventory, and occasionally other line items such as marketable securities. You need to have more current assets than current liabilities on your balance sheet at all times.The quick ratio will allow you to determine if you can pay your short-term debt obligations, or current liabilities, without having to sell any inventory. It's important for a firm to be able to do this because, if you sell have to sell inventory to pay billsthat means you have to find a buyer for that inventory. Finding a buyer is not always easy or possible.There is various other measure of liquidity that you will want to use to determine your cash position.2.2Cash FlowCash flow is the movement of cash into or out of a business, project, or financial product. (Note that "cash" is used here in the broader sense of the term, where it includes bank deposits.) It is usually measured during a specified, finite period of time. Measurement of cash flow can be used for calculating other parameters that give information on the companies' value and situation. Cash flow can e.g. be used for calculating parameters:To determine a project's rate of return or value. The time of cash flows into and out of projects are used as inputs in financial models such as internal rate of return, and net present value.To determine problems with a business's liquidity. Being profitable does not necessarily mean being liquid. A company can fail because of a shortage of cash, even while profitable.As an alternate measure of a business's profits when it is believed that accrual accounting concepts do not represent economic realities. For example, a company may be notionally profitable but generating little operational cash (as may be the case for a company that barters its products rather than selling for cash). In such acase, the company may be deriving additional operating cash by issuing shares, or raising additional debt finance.Cash flow can be used to evaluate the 'quality' of Income generated by accrual accounting. When Net Income is composed of large non-cash items it is considered low quality.To evaluate the risks within a financial product, e.g. matching cash requirements, evaluating default risk, re-investment requirements, etc.Cash flow is a generic term used differently depending on the context. It may be defined by users for their own purposes. It can refer to actual past flows, or to projected future flows. It can refer to the total of all the flows involved or to only a subset of those flows. Subset terms include 'net cash flow', operating cash flow and free.Figure : Cash Inflow and Cash Outflow from a Company’s PerspectiveAccording to the Financial Accounting Standards Board (FASB), the major recipients of cash accounting information that is contained in a cash flow statement are the following groups：Investors, lenders, suppliers, employees―To investors, lenders, suppliers, and employees, a business enterprise is a source of cash in the form of dividends or interests …, repayment of borrowing, payment for goods or services, or salaries or wages. They invest cash, goods, or services … expect to obtain sufficient cash in return …‖Customers―To custome rs, a business enterprise is a source of goods or service, but only by obtaining sufficient cash to pay for the resources it uses—and to meet its other obligations—can the enterprise provide those goods or services.‖Management―To managers, the cash flow s of a business enterprise are a significant part of their management responsibilities, including their accountability to directors and owners.‖2.3 Statement of cash flow in a business's financialsThe (total) net cash flow of a company over a period (typically a quarter or a full year) is equal to the change in cash balance over this period: positive if the cash balance increases (more cash becomes available), negative if the cash balance decreases. The total net cash flow is the sum of cash flows that are classified in three areas:1.Operational cash flows:Cash received or expended as a result of thecompany's internal business activities. It includes cash earnings plus changes to working capital. Over the medium term this must be net positive if the company is to remain solvent.+ Incoming payments from customers– Outgoing payments to suppliers= Cash flow from operating activities2.Investment cash flows:Cash received from the sale of long-life assets, orspent on capital expenditure (investments, acquisitions and long-life assets).+ Incoming payments from asset retirements–Outgoing payments for asset acquisitions+ Incoming payments from financial asset retirements–Outgoing payments for investments in financial assets= Cash flow from investing activities3.Financing cash flows:Cash received from the issue of debt and equity, orpaid out as dividends, share repurchases or debt repayments.+ Incoming payments from equity allocations–Outgoing payments to company shareholders+ Incoming payments from borrowings–Outgoing payments for loans= Cash flow from financing activitiesWays Companies Can Augment Reported Cash FlowSales - Sell the receivables to a factor for instant cash. (leading)Inventory - Don't pay your suppliers for an additional few weeks at period end.(lagging)Sales Commissions - Management can form a separate (but unrelated) company and act as its agent. The book of business can then be purchased quarterly as an investment.Wages - Remunerate with stock options.Maintenance - Contract with the predecessor company that you prepay five years worth for them to continue doing the workEquipment Leases - Buy itRent - Buy the property (sale and lease back, for example).Oil Exploration costs - Replace reserves by buying another company's.Research & Development - Wait for the product to be proven by a start-up lab;then buy the lab.Consulting Fees - Pay in shares from treasury since usually to related partiesInterest - Issue convertible debt where the conversion rate changes with the unpaid interest.Taxes - Buy shelf companies with TaxLossCarryForward's. Or gussy up the purchase by buying a lab or O&G explore co. with the same TLCF.Example:The net cash flow only provides a limited amount of information. Compare, for example, the cash flows over three years of two companies:Company A Company BYear 1 Year 2 year 3 Year 1 Year 2 year 3 Cash flow from operations +20M +21M +22M +10M +11M +12M Cash flow from financing +5M +5M +5M +5M +5M +5M Cash flow from investment -15M -15M -15M 0M 0M 0M Net cash flow +10M +11M +12M +15M +16M +17MCompany B has a higher yearly cash flow. However, Company A is actually earning more cash by its core activities and has already spent 45M in long term investments, of which the revenues will only show up after three years.3.Liquidity managementManaging liquidity is a fundamental component in the safe and sound management of all financial institutions. Sound liquidity management involves prudently managing assets and liabilities (on- and off-balance sheet), both as to cash flow and concentration, to ensure that cash inflows have an appropriate relationship to approaching cash outflows. This needs to be supported by a process of liquidity planning which assesses potential future liquidity needs, taking into account changes in economic, regulatory or other operating conditions. Such planning involves identifying known, expected and potential cash outflows and weighing alternative asset/liability management strategies to ensure that adequate cash inflows will be available to the institution to meet these needs.The objectives of liquidity management are:Honoring all cash outflow commitments (both on- and off-balance sheet) on an ongoing, daily basis;Avoiding raising funds at market premiums or through the forced sale of assets;andSatisfying statutory liquidity and statutory reserve requirements.Although the particulars of liquidity management will differ among institutions depending upon the nature and complexity of their operations and risk profile, a comprehensive liquidity management program requires:Establishing and implementing sound and prudent liquidity and funding policies;andDeveloping and implementing effective techniques and procedures to monitor measure and control the institution’s liquidity requirements and position.4.Cash Flow managementThe bottom line to good cash management is that, in a crisis, typical financial statements become irrelevant and all that is important is surviving from a cash point of view. In a cash crisis, such as a recession, a business owner's focus becomes, by necessity, very short-term. Often, a cash crisis will instill good cash management practices into business managers that carry over from that day forward. Managers have to understand how to prepare a monthly cash budget. Next, they must understand sources and uses of cash like are stated on the Statement of Cash Flows, one of three required financial statements. The feedback you get from these financial statements is invaluable. Starting with inventory and accounts receivable, if managers can maximize their cash flow, they can almost always avoid running out of operating cash and exposing themselves to cash flow problems.How to Maximize Your Cash FlowYour goal, as the owner and manager of your company, is to squeeze all the cash out of your balance sheet that you can. Not only do you want to get as much cash out of your company as you can, you want to keep it out in case of a potential or actual crisis.Two of your current asset accounts are usually big drains on your cash. They are inventory and accounts receivable. Inventory is the products you sell and accountsreceivable are your credit accounts or those the accounts that represent the credit you extend to customers. The balances in both accounts need to be converted to cash as soon as possible.You can use financial ratio analysis to check out your position regarding inventory and accounts receivables. Inventory turnover ratios can tell you if your inventory is obsolete or if you are selling so fast you are stocking out. Accounts receivable ratios, such as day’s sales outstanding, can tell you how fast your credit customers are cleaning up their accounts among other things. Once you determine the position of your inventory and receivables, you can take the appropriate actions to adjust the situations and have more cash coming in to your firm.Another way to get more cash into your business regarding your credit customers and accounts receivables is using a lockbox system to collect payments. If you have payments wired or mailed to a lockbox, those payments get into your account faster. Your bank can then sweep funds into interest-bearing accounts.Another short-term strategy to squeeze money out of your balance sheet is to look at the current liabilities on your balance sheet. Focus on your accounts payable. They are what you owe your suppliers. Pay your accounts payable on the day they are due, not early. There is no reason to give your suppliers the use of your cash days before the bill is due. Your business needs to have use of that cash. Stretch out the use of your funds.5.Cash Accounting and Liquidity PlanningIn busin ess literature, you’ll find countless discussions about the concept of cash accounting and its definition. In these discussions, you’ll also encounter the following Terms: cash budget management, flow-of-funds analysis, and cash flow statement, as well as cash flow accounting.Cash accounting records the changes of cash flows, cash flows being incoming and outgoing payments of liquid funds such as cash in hand and bank savings.In accordance with national and international accounting standards such as FASB and IAS, we will use the term“cash flow‖ to describe the changes in the means of payment. Liquidity is therefore referred to as a financial accounting-related concept. Within a certain period, cash accounting records transactions that have a direct influence on the stock of liquid funds, regardless of the period the payments refer to. In addition, it is now apparent that in business theory, cash accounting always refers to several periods. The Liquidity Planner component consists of two applications, the first application, Actual Calculation, refers to past and current periods, while the other application future periods.6.Case Scenario:Implementing Cash Accounting and Liquidity Planning Based on a specific real-life situation that we’ve encountered several times, we will build up a scenario for implementing SAP Liquidity Planner. This example is used to support your understanding of the functionality and the technical concept of SAP Liquidity Planner, but it will also serve as an aide in helping you to implement this component. The initial situation looks as follows: We’ll consider an international corporation, the IDES Group, which is structured as follows:The corporate headquarters is in Germany. The central departments of corporate accounting and global treasury are also located in Germany.Legally independent production sites exist in Germany and Eastern Europe.The sales and distribution network stretches across Europe and the US, with legally independent sales companies in the respective countries.Research and development is located at corporate headquarters in Germany.IDES uses SAP as its standard business software with the currently implemented applications:SAP FI for accountingSAP CO for controllingSAP SD for sales and distributionSAP MM for materials managementSAP PP for production7.ConclusionsJust like an individual or a family, companies need cash cushion to rely on. This gives them security in unstable times. It also gives them an opportunity to take advantage of strategic investments or take advantage of opportunities to reduce costs. Small businesses also have to focus on the concept of free cash flow in order to establish that cash cushion.When your business is just starting up, you essentially run it out of a check book, which is an example of cash accounting. As long as there is cash in the account, your business is solvent. As your business becomes more complex, you will have to adopt financial accounting. However, you have to keep a focus on liquidity and cash management even though you track net income through financial accounting. Focusing on liquidity comes more naturally to a CEO than to an accountant who is trained to practice accrual accounting.One of the first things that successful businesses did during the recession was to look at their borrowing and renegotiate the terms to something that, while it may be over more years and ultimately more expensive, has lower payments now. Yes, adding more debt is probably a bad idea for most businesses, but if refinancing existing debt allows you to stay in business, there's a definite upside to doing it.In a word, the making money flow inside, there were a few tricksReference:Books:Financial management and real options Jack BroylesModern financial management Ross, westerfield, Jaffe Financial Management An introduction Jim Mcuenamin Websites:/od/cashmanagement/a/cash_mngt.htm /wiki/Cash_flow/publications/review/F09-4-Liquidity.asp。
