First, knowing your company’s cash situation will help you understand what is going on now, where the business is headed, and what senior management’s priorities are likely to be. You need to know not just whether the overall cash position is healthy but specifically where the cash is coming from. Is it from operations? That’s a good thing – it means the business is generating cash. Is investing cash flow a sizeable negative number? If it isn’t, it may mean that the company isn’t investing in its future. And what about financing cash flow? If investment money is coming in, that may be an optimistic sign for the future, or it may mean that the company is desperately selling stock to stay afloat. Looking at the cash flow statement may generate a lot of questions, but they are the right ones to be asking. Are we paying off loans? Why or why not? Are we buying equipment? The answers to those questions will reveal a lot about senior management’s plan for the company.
Second, you affect cash. As I’ve said before, most managers focus on profit, when they should be focusing on both profit and cash. Of course, their impact is usually limited to operating cash flow – but that’s one of the most important measures there is. For instance:
· Accounts receivable. If you’re in sales, are you selling to customers who pay their bills on time? Do you have a close enough relationship with your customers to talk with them about payment terms?[1] If you’re in customer service, do you offer customers the kind of service that will encourage them to pay their bills on time? Is the product free of defects? Are the invoices accurate? Does the mail room send invoices timely? Is the receptionist helpful? All these factors help determine how customers feel about your company, and indirectly influence how fast they are likely to pay their bills. Disgruntled customers are not known for prompt payments – they like to wait until any dispute is resolved.
· Inventory. If you’re in engineering, do you request special products all the time? If you do, you may be creating an inventory nightmare. If you’re in operations and you like to have lots in stock, just in case, you may be creating a situation in which cash is just sitting on the shelves, when it could be used for something else. Manufacturing and warehouse managers can often reduce inventory hugely by studying and applying the principles of “lean” enterprise, pioneered at Toyota.
· Expenses. Do you defer expenses when you can? Do you consider the timing of cash flow when making purchases? Obviously, I’m not saying it’s always wise to defer expenses; it’s just wise to understand what the cash impact will be when you do decide to spend money, and to take that into account.
· Giving credit. Do you give credit to potential customers too easily? Alternatively, do you withhold credit when you should give it? Both decisions affect the company’s cash flow and sales, which is why the credit department always has to strike a careful balance.
The list goes on. Maybe you’re a plant manager, and you are always recommending buying more equipment, just in case the orders come in. Perhaps you’re in IT, and you feel that the company always needs the latest upgrades to its computer systems. All these decisions affect cash flow, and senior management usually understands that very well. If you want to make an effective request, you need to familiarise yourself with the numbers that they are looking at.
Third, managers who understand cash flow tend to be given more responsibilities, and thus tend to advance more quickly, than those who focus purely on the income statement. In the following part, for instance, you’ll learn to calculate ratios such as days sales outstanding (DSO), which is a key measure of the company’s efficiency in collecting receivables. The faster receivables are collected, the better a company’s cash position. You could go to someone in finance and say, “Say, I notice our DSO has been heading in the wrong direction over the last few months – how can I help turn that around?” Alternatively, you might learn the precepts of lean enterprise, which focuses on (among other things) keeping inventories to a minimum. A manager who leads a company in converting to lean thereby frees up huge quantities of cash.
But my general point here is that cash flow is a key indicator of a company’s financial health, along with profitability and shareholders’ equity. It’s the final link in the triad, and you need all three to assess a company’s financial health. It’s also the final link in the first level of financial intelligence.
[1] There is an argument to be made, though, that it may not be desirable for your salespeople to discuss payment terms with customers in case they alienate them (except, of course, in negotiating contracts). In a “good cop, bad cop” situation, your salespeople always play “good cop” and leave the “bad cop” part to credit control.
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