Improving cash flow using credit management – CIMA

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Improving cash flow
using credit management
The outline case




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                                                              Improving cash flow using credit management   




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          CIMA, Chartered Institute of Management
          Accountants, champions management
          accountancy worldwide. In an age of growing
          globalisation and intensified competition, modern
          businesses demand timely and accurate financial
          information. That is why its members are sought
          after by companies across the world. They are
          commercial managers with wide ranging skills.
                                                                          Improving cash flow using credit management       




Foreword
This guide explores credit and cash management in small and medium sized enterprises and includes advice on
maximising cash inflows, managing cash outflows, extending credit and cash flow forecasting. It is not intended to be
complex or exhaustive, but rather to act as a basic guide for financial managers in smaller businesses.

Cash flow management is vital to the health of your business. The oft-used saying, `revenue is vanity, profit is sanity;
but cash is king` remains sage advice for anyone managing company finances. To put it another way, most businesses
can survive several periods of making a loss, but they can only run out of cash once.

The importance of cash flow is particularly pertinent at times when access to cash is difficult and expensive. A credit
crunch creates extreme forms of both of these problems. When the `real economy' slips into recession, businesses face
the additional risk of customers running into financial difficulty and becoming unable to pay invoices  which, allied to
a scarcity of cash from non-operational sources such as bank loans, can push a company over the edge.

Even during buoyant economic conditions, cash flow management is an important discipline. Failure to monitor credit,
assess working capital  the cash tied up in inventory and monies owed  or ensure cash is available for investment can
hamper a company's competitiveness or cause it to overtrade.

From its headquarters in London and eleven offices outside the UK, CIMA supports over 171,000 members and students
in 165 countries. CIMA's focus on management functions makes them unique in the accountancy profession. The CIMA
qualification is recognised internationally as the financial qualification for business and its reputation and value are
maintained through high standards of assessment and regulation.

For further information please contact:

CIMA Innovation and Development
T. +44 (0)20 8849 2275
E. innovation.development@cimaglobal.com
                                                                 Improving cash flow using credit management   



Contents

Improving cash flow using credit management - the outline case                                            5
Working capital                                                                                           6
1. The cash flow cycle                                                                                    7
Inflows                                                                                                   7
Outflows                                                                                                  7
Cash flow management                                                                                      7
Advantages of managing cash flow                                                                          8
Cash conversion period                                                                                    9
2. Acclerating cash inflows                                                                              10
Customer purchase decision and ordering                                                                  10
Credit decisions                                                                                         10
Fulfilment, shipping and handling                                                                        10
Invoicing the customer                                                                                   10
Special payment terms                                                                                    11
The collection period                                                                                    11
Late payment: a perennial problem                                                                        11
The Late Payment of Commercial Debts (Interest) Act 1998                                                 12
Bad debts                                                                                                12
Improving your debt collection                                                                           12
Payment and deposit of funds                                                                             12
3. Credit management                                                                                     14
Credit policy                                                                                            14
Credit in practice                                                                                       14
Credit checking: where and how                                                                           14
Credit insurance                                                                                         15
4. Cash flow forecast               16
Forecasting cash inflows            16
Average collection period           16
Accounts receivable to sales ratio  17
Accounts receivable ageing schedule 17
Forecasting cash outflows           18
Accounts payable ageing schedule    18
Projected outgoings                 19
Putting the projections together20
5. Cash flow surpluses and shortages21
Surpluses21
Shortages21
Factoring and invoice discounting21
Asset sales22
6. Using company accounts23
Current ratio23
Liquidity ratio or acid test or quick ratio23
ROCE (Return on Capital Employed)23
Debt/equity (gearing)23
Profit/sales24
Debtors' days sales outstanding24
Creditor's days sales24
7. Cash management, credit and overtrading: a case study25
8. Conclusion26
9. Further reading                                                                                       27
                                                                           Improving cash flow using credit management        



Improving cash flow using credit management 
the outline case
Cash flow is the life blood of all businesses and is the primary indicator of business health. It is generally acknowledged
as the single most pressing concern of most small and medium-sized enterprises (SMEs), although even finance
directors of the largest organisations emphasise the importance of cash, and cash flow modelling is a fundamental part
of any private equity buy-out. In a credit crunch environment, where access to liquidity is restricted, cash management
becomes critical to survival.

In its simplest form, cash flow is the movement of money in and out of your business. It is not profit and loss, although
trading clearly has an effect on cash flow. The effect of cash flow is real, immediate and, if mismanaged, totally
unforgiving. Cash needs to be monitored, protected, controlled and put to work. There are four principles regarding
cash management:

  1. Cash is not given. It is not the passive, inevitable outcome of your business endeavours. It does not arrive in your
     bank account willingly. Rather it has to be tracked, chased and captured. You need to control the process and there
     is always scope for improvement.
  . Cash management is as much an integral part of your business cycle as, for example, making and shipping widgets
     or preparing and providing detailed consultancy services.
  . Good cash flow management requires information. For example, you need immediate access to data on:
      your customers' creditworthiness
      your customers' current track record on payments
      outstanding receipts
      your suppliers' payment terms
      short-term cash demands
      short-term surpluses
      investment options
      current debt capacity and maturity of facilities
      longer-term projections.
  4. You must be masterful. Managing cash flow is a skill and only a firm grip on the cash conversion process will yield
     results.
Professional cash management in business is not, unfortunately, always the norm. For example, a survey conducted by
the Better Practice Payment Group in 2006 highlighted that one in three companies do not confirm their credit terms
in writing with customers. And many finance functions do not maintain an accurate cash flow forecast (which is crucial,
as we'll see later).

Good cash management has a double benefit: it can help you to avoid the debilitating downside of cash crises; and it
can grant you a commercial edge in all your transactions. For example, companies able to aggressively manage their
inventory may require less working capital and be able to extend more competitive credit terms than their rivals.
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