Manage Your Cash to Drive Profitable Growth — August 2015

This topic concerns Treasury.

Cash management is a key function of the CFO. Cash is the lifeblood of profitability and growth, thus the CFO must be intricately involved in optimizing best practices; bank relationships; and working capital management.

Best Practices entail utilizing the most effective means of generating substantial positive cash flow on a timely basis. A widely accepted Best Practice is Positive Pay whereby the bank is presented checks prepared by the company and compares the payees with a list provided by the CFO. If the payee is not on the list, the bank will not honor the check and consult with the company about the matter. While an excellent Best Practice , there are many others which can be implemented. These involve management of cash flow, bank services, and fraud detection.

Management of cash flow is crucial for the company to operate effectively and fund growth opportunities. Important Best Practices for management of cash flow follow.

The CFO can speed up collections by several means. One is using remote deposit service. Another is using ACH payments rather than receiving checks whenever it is practical. Finally, the CFO can arrange for the automatic re-presentation of NSF checks.

Slowing disbursements can be accomplished in several ways. For accounts payable, the CFO can use a credit card to pay bills; make electronic payments on the precise due date; and consider outsourcing the payables function, if feasible. For payroll, the CFO should utilize a payroll service and pay with direct deposit.

The CFO must establish a framework for cash forecasting and operations. This can be accomplished by using cash forecasting software or third party services. However most CFOs want to maintain better control. Thus internal spreadsheets will suffice if there are robust controls, protection, and documentation. Furthermore, the CFO must know how the various cells in the spreadsheet operate and relate to each other.

A bank of high quality that provides necessary services is essential to good management of cash. This can be ascertained by obtaining rating information from various third parties such as the Banking Administration Institute. The CFO can also ask that the prospective bank provide copies of any customer surveys it has conducted.

Once a bank of acceptable quality is selected, bank agreements must be put into place. The CFO must negotiate the means for banks to compensate the firm for keeping its balance there. Desirable components of the agreements include payment of a fixed fee rather than compensating balances; a credit against fees based on how much business the firm gives the bank; and compensating the bank quarterly rather than monthly. Finally, the CFO should track costs and chart trends to detect unfavorable patterns in the amount the firm pays the bank.
The CFO should present the bank with an RFP every three years and demand a two year written price guarantee to ensure that the firm always receives competitive bank pricing for the services the bank provides.

Banks are the firm’s key partner in check and wire fraud prevention. The bank and the CFO should agree upon a procedure to flag checks that appear to be fraudulent. In addition, the firm should have its own controls in place to detect fraudulent activity. Among such controls are segregation of check writing functions; dual signatures; and signature verification.

Cash management is critical for sufficient liquidity and, accordingly, profitable growth. In turn, a key element of cash management are strong Bank Relationships Once the CFO has selected a bank that meets sufficient quality criteria, fair agreements, and favorable pricing, he (she) must focus on the important best practices for Bank Relationships.

These Bank Relationships set the framework under which the aforementioned best practices can be implemented. The Bank Relationship can be viewed through the prism of two elements: the CFO’s obligation to the bank and the objectives of the bank relationship..

The CFO’s obligations to the bank are straight forward. They include transparency, compliance with bank terms and policy, and building a strong personal relationship with the key banker. The latter entails educating the banker to understand the company’s business and building trust by promptly alerting the bank to any problems that may arise or are imminent.

The objectives of the banking relationship are multi-faceted. One is to maintain access to credit for funding of working capital and operating needs. Another is to obtain basic but necessary banking services for smooth operation of the business. The CFO must also manage costs effectively, as detailed under the best practices above, while monitoring the bank’s financial stability through internal analysis and third party services such as Value Line, SNL, and Wall Street brokerage reports. These objectives should be pursued under the umbrella of a partnership approach that emphasizes a mutually beneficial relationship.

Another crucial element of cash management is Working Capital Management, which is the daily management of current assets and current liabilities. The major objective is to hold sufficient current assets to support the companies operations as well as minimizing the costs and restrictions (including bank covenants) of liabilities incurred to support day to day activities. There are several important elements of this function.

There are three types of working capital management strategies. The CFO can choose to match current assets with current liabilities such that overall balances are equal. The result is self-liquidating liabilities. Alternatively, the CFO can pursue a conservative strategy whereby current assets exceed current liabilities. While this sacrifices increased profit potential, it protects the company in case of contingencies such as the inability to rollover its line of credit. An aggressive strategy is where the company maintains current assets, less than current liabilities. This is the use of “other people’s money” to increase profits at the expense of safety. Each strategy has it pros and cons. The chosen strategy should be compatible with the operating philosophy of the CEO and comfortable for the CFO. Regardless of which strategy is chosen, the goal is to reduce the cash conversion cycle.

The Cash Conversion Cycle is the average period of time a company’s funds are tied up in working capital before being converted to cash. It can be calculated as DAYS IN RECEIVABLES + DAYS IN INVENTORY – DAYS IN PAYABLES. Each component can be easily calculated by the CFO. The goal of the CFO is to reduce the time period without compromising supplier relationships, stock-outs, and losing customers.

To reduce the cash conversion cycle, the CFO must concentrate on the three components of the measure. First, collect Accounts Receivable faster. This can be accomplished through such means as more efficient and faster invoicing, persistent collection practices, and robust credit granting procedures.

Second the CFO can focus on increasing inventory turnover. There are many ways to do this, many of which involve Lean and Six Sigma principles that have been successfully applied at high performing public companies. Such means include “just-in-time” policies; shorter production schedules; and matching production with demand.

Third, accounts payable should be stretched as long as practical. This means do not pay the accounts until the due date, unless a discount if offered. In that case, it is usually wise to take the discount since the value of the discount normally outweighs the short term return on the holding the cash longer.

Cash management is a key function of the CFO. Cash is the lifeblood of profitability and growth, thus the CFO must be intricately involved in optimizing best practices; bank relationships; and working capital management. Best Practices entail utilizing the most effective means of generating substantial positive cash flow on a timely basis. Bank relationships are built on straightforward communications which foster an atmosphere of trust and creates a shared vision of a mutually beneficial relationship.
Working Capital Management, is the daily management of current assets and current liabilities. The major objective is to hold sufficient current assets to support the companies operations as well as minimizing the costs and restrictions (including bank covenants) of liabilities incurred to support day to day activities.

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