Question

In light of the information provided below, answer the following questions:

5.1 Explain how the preparation of a statement of cash flows could assist in cash management. (10)

5.2 Suggest FIVE (5) strategies that may be used to reduce the duration of cash conversion cycles. (10)

INFORMATION Business analysts report that poor management is the main reason for business failure. Poor cash management is probably the most frequent stumbling block for entrepreneurs. Understanding the basic concepts of cash flow will help one plan for the unforeseen eventualities that nearly every business faces. It is also important for entrepreneurs to keep the duration of their cash conversion cycles as low as possible.

Answer 1

Answer to question 5.1

Preparation of a statement of cash flows is inevitable in good cash management, because it involves :

• Knowing when, where, and how your cash needs will occur;
• Knowing the best sources for meeting additional cash needs; and
• Being prepared to meet these needs when they occur, by keeping good relationships with bankers and other creditors.

The starting point for good cash flow management is developing a cash flow projection. Smart business owners know how to develop both short-term (weekly, monthly) cash flow projections to help them manage daily cash, and long-term (annual, 3-5 year) cash flow projections to help them develop the necessary capital strategy to meet their business needs. They also prepare and use historical cash flow statements to understand how they used money in the past.

Answer to question 5.2

The cash conversion cycle measures the time passed from the beginning of the production process to collection of cash from the sale of the finished product. Typically a firm buys raw materials and produces a product. This product goes into inventory and then is sold. Once the product is sold then the firm waits to receive payment, at which point the process begins again. How long does this take? Understanding this cycle is essential to successful working capital management.

Strategies that may be used to reduce the duration of cash conversion cycles are :

1. Reduce the average age of inventory. Improve their inventory conversion period by making goods and selling them faster through more efficient processes.
2. Avoiding inventory shortages or stock-outs helps too.
3. Reduce the average collection period. Speed up collections on accounts receivable. Collect A/R as quickly as possible without losing customers but maintain good credit relations with customers.
4. Increase the payable deferral period. Pay A/P as slowly as possible without harming credit rating or relationship with supplier.
5. Use technology, strategic partnerships and other leverages effectively. Use technology to collect payments, make product or any other use of technology which improves efficiency.