Question

From the scenario, analyze TFC's cash budget to determine key methods in which the budget may be optimized (e.g., by renegotiating terms and conditions on some of its payables, etc.). If you believe that there is room for improvement, recommend key strategies for TFC to use in order to optimize its cash budget. If you do not believe that this is the case, provide a rationale for your response.

Answer 1

According to the question,

Optimizing the Cash Budget

To establish a sound cash management culture within TFC, requires a management buy-in. TFC should define its objectives up front, assign responsibility to people across the organization, and then track progress using monthly cash flow metrics. It is of utmost importance to establish, communicate and implement standard Cash Management policies across TFC.

Cash management policies need to focus on budgeting, forecasting and financing and indicate how to handle day-to-day activities such as collections, procurement/ordering and payment. All departments – from sales and marketing, procurement and production to finance and treasury – must coordinate for optimal results.

Managing cash requires organization-wide financial discipline and a clear working capital optimization strategy. If TFC does not have a formal working capital strategy, has not adopted appropriate drivers and metrics, or simply has not communicated clear policies across the organization, it may be missing out on opportunities to target free-cash targets, reduce costs, increase shareholder returns and fund growth. This is inspite of being conservative.

While there are numerous ways to free up working capital, suggestions made below focuses on four core strategy pillars, viz., Accounts Receivable, Accounts Payable, Inventory and Cash Management.

Accounts receivable, accounts payable and inventory are all components of working capital that TFC can streamline to access cash trapped in its Balance Sheet. When approached holistically, however, proper management of accounts receivable, accounts payable and inventory all fall under the umbrella of effective cash management.

To improve any of these levers, TFC create a cash management culture. For its senior management, this means going beyond prioritizing cash flows in an effort to free up cash. It means encouraging financial and cash flow discipline in both good and more difficult economic times, through adoption of some or all of the suggestions made below :

1. Using technology to shorten the cash conversion cycle

By delivering invoices electronically rather than via mail, TFC can speed up billing and collection. It is assumed that TFC has not already implemented this strategy.

By implementing a vendor portal, TFC could provide vendors, electronic access to its invoices, enable electronic payments and reduce the time it takes to resolve disputes. These solutions would provide TFC with timely and robust reporting that can help it take proactive steps to resolve delinquent accounts or take advantage of supplier discounts.

2. Optimizing TFC's financial functions :

There are a wide range of optimization techniques that TFC can adopt to improve its cash management. For instance, effective accounts receivable practices include reducing error rates on invoices and adopting a regular schedule to follow up on collections.

TFC does not collect 45% of the payments in the current month, thereby opening the business to competition. This is inspite of the 99% collection rate. Theefore, there will be months with negative amounts. The company should thus re-structure the payment plan to obtain a 10 million target for each month.

Effective accounts payable practices include negotiating or re-negotaiting favourable terms and rebates with suppliers, issuing purchase orders for new orders, using available volume rebates and trade spend initiatives, and periodically benchmarking vendor contracts against industry standards.

3. Making it visible – Cash Flow Reporting

In order to facilitate embedding and implementation of a cash management culture, TFC needs to actively track its cash flows. Forecasting is a critical step in cash management and ultimately improving profitability. This involves looking at both income and cash flow statements, and linking cash flow forecasts to key working capital metrics from the balance sheet, such as DIO (days inventory on-hand), DSO (days sales outstanding) and DPO (days payables outstanding).

TFC should include capital expenditures, debt repayments and other operating cash flows so that management is aware of the full spectrum of cash requirements, in the event that it is planning for a major expansion project. .

To enhance the accuracy of forecasts, TFC mustr consider automating the Cash Flow Reporting process rather than relying on error-prone and labour intensive spreadsheets with non-existent data integrity.

It would help TFC to actively review variances in actual results as compared to forecast and use this process to refine and improve the accuracy of your forecast assumptions.

TFC could integrate cash flow forecasting with the Income statement and Balance Sheet to enable tracking performance against a range of indicators. When times are tight, cash management can be even more important, buying time with key stakeholders, reducing the likelihood of covenant breaches and minimizing the need for additional financing.

TFC should be flexible to adopt a weekly cash flow forecasting and reporting process. This could improve visibility and reliability of information, and consider establishing a cash committee to oversee this process and drive change through the organization.

4. Matching funding to your cash flow obligations

Every business has both short- and long-term cash flow obligations. Short-term requirements encompass day-to-day operational expenses. Longer-term obligations typically refer to capital project investments and term debt maturities.

To become proficient at cash flow management, TFC should match their various sources of funding to its capital flows. This ensures that an otherwise conservative and profitable business has access to the cash it needs to meet its ongoing obligations.