Question

Discuss and explain the importance and methods for preparing a financial plan including the five steps in creating a cash budget and the fundamental principles involved in managing the “Big Three” of cash management: accounts receivable, accounts payable, and inventory. Provide an example.

Answer 1

Understand the five steps in creating a cash budget and use them to create a cash budget.

• The cash budgeting procedure outlined in this chapter tracks the flow of cash through the business and enables the owner to project cash surpluses and cash deficits at specific intervals.
• The five steps in creating a cash budget are as follows: determining a minimum cash balance, forecasting sales, forecasting cash receipts, forecasting cash disbursements, and determining the end-of-month cash balance.

Describe fundamental principles involved in managing the “big three” of cash management: accounts receivable, accounts payable, and inventory.

• Controlling accounts receivable requires business owners to establish clear, firm credit and collection policies and to screen customers before granting them credit. Sending invoices promptly and acting on past-due accounts quickly also improve cash flow. The goal is to collect cash from receivables as quickly as possible.
• When managing accounts payable, a manager’s goal is to stretch out payables as long a possible without damaging the company’s credit rating. Other techniques include verifying invoices before paying them, taking advantage of cash discounts, and negotiating the best possible credit terms.
• Inventory frequently causes cash headaches for small business managers. Excess inventory earns a zero rate of return and ties up a company’s cash unnecessarily. Owners must watch for stale merchandise.