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Managing your Finances:
Cash Flows
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Cash is the lifeblood of every business. It is the most important asset for the operations of a business. A healthy cash flow management is indispensable for a successful business. Cash flow refers to the movement of money in and out of a business during a specific period of time. It is a record of a company's income and expenses. It is calculated as the difference between cash inflows and cash outflows of a business. Cash inflow is defined as the movement of money into a business from the sale of goods or services to the customers. Whereas,cash outflow is defined as the movement of money out of a business in the form of payment of expenses.

Cash flows of a company can be classified into following:-

  • Operational cash flows:- Cash comes and goes out of business as a result of the core business activities,that is,due to the regular operations of the business.For example,receipts from sales,expenses on purchasing raw materials,etc.

  • Investment cash flows:- Cash received or disbursed by making capital expenditures,investments or acquisitions that will benefit the business in the long run.For example,investment in Plant and Machinery,etc.

  • Financial cash flows:- Cash received or disbursed as a result of financial activities, such as receiving or paying loans, issuing or repurchasing stock, and paying dividends.

It is used to examine income or growth of a business.In case your cash flow position is disturbed and you find it very difficult to pay back your suppliers or creditors or making payments to employees,then you may have to close your business.Thus it becomes necessary to manage your cash flows so that you can pay back loans on time and are able to get,if needed,again in future.

Cash flow management means maintaining regular and increasing amount of cash inflows at right time so that it can be easily available to make cash outlays as and when needed. The idea is to reduce the time lag between cash receipts and its disbursement.The twin objectives in managing the cash flows are:-

  • To accelerate cash collections - In order to conserve cash and reduce its requirements for keeping cash balances,a firm aims to speed up its cash collections. Following techniques can be used for this purpose:

    • Taking payments from the customers in the safe modes like demand drafts,letters of credit,bills of exchange,etc.

    • Self-addressed envelope can be sent along with the bill or invoice to the customers to induce them to make prompt payments. Allowing cash discounts can be an alternative option.

    • Faster means of communications such as courier services,speed post,etc. can be used while dealing with outstation customers so as to avoid postal float.

    • In case of the company which has the branches at different places,the company can establish 'decentralised collection' centres.Under this,the company has a large number of bank accounts operated in the areas where it has branches.The customers in a certain area are required to make the payment at the local collection centre and the cheques collected by the local collection centre are deposited in the local bank account.

    • The company can use 'Lock-box system' method. Under it,the company hires a post office box called the lock-box and is located at important collection centres.The customers are instructed to make the payment directly to lock box.The local bankers of the company are authorised to pick up cheques from box and credit to the company's accounts.

  • To delay cash payments - the aim is to slow down the cash payments as much as possible.This can be done with the help of following techniques:

    • Attempts should be made by the company to get the maximum credit for the goods and services supplied by it.

    • Payments to be made from single central account.

    • Use of bank draft rather than cheques in making payments.

    • Payments can be made from a bank which is distant from the bank of the company to which the payment is to be made.This way transit time increases and firm will gain by this delay.

    • If a company is required to make the payment within the stipulated period,it should not make payment before the specified date unless the company is entitled to cash discounts.

To effectively manage the cash flows,the companies needs to do cash planning.It is a technique to plan for and control the use of cash. It helps to anticipate present as well as the future cash flows and needs of the firm.It will synchronise the gap between cash surpluses and shortages.The best tool available with the company to assess its needs for cash properly is to prepare the cash budget.A cash budget is the statement showing estimated sources of cash receipts ( cash inflows) on one hand and the various applications of cash (cash outflows) on the other hand.

The various items listed under cash inflows are :- cash sales ; collection from debtors ; interest/dividend received ;issue of shares or debentures ;receipt of loans or borrowings ; sale of fixed assets,etc.

While,the various items under Cash outflows are:- payment to creditors; purchases of raw material ; wages or salaries ; various kinds of overheads; redemption of shares/debentures ; loan installments ; purchase of fixed assets ;purchase of fixed assets ;interest;taxes;dividends,etc.

All companies must consult an accountant for managing its cash flows properly. Cash flow management begins with identifying the sources and the amount of income and expenditure of a company.

A firm can manage its cash flows by following certain basic rules of accounting in the manner as described below:-

  • Understand the cash flows in a broader perspective in order to any avoid financial troubles in future.It is also considered as a fuel to run your business efficiently.

  • Measure the cash flows and the changes in it over a time-period and categorize company's cash receipts and outlays for every financial year. This can be done by preparing a statement of cash flows on monthly,weekly or daily basis depending upon the requirement of business. The statement determines the short-term sustainability of business. If cash is increasing (and cash flow is positive) then a company will be deemed as healthy and solvent in the short-term and able to meet its cash needs. If the company is seeking a loan,the statement shows the lender as to how the company is going to pay back loans and what is its present standing.

  • Analyse cash flows which is done to compare timing and amount of cash inflows with that of cash outflows. This will help the company plug problematic areas in cash flow cycle of the business and also highlights the situations of cash shortages or cash surpluses. It also highlights the ability of a company to meet its obligation of long-term debt with its internally generated cash.

  • Forecast cash flow of the business,that is,anticipate how much money the company will receive and how much it will spend in different operations. Cash flow projection involves, adding cash on hand at the beginning of the period along with other cash receipts from various sources and then adjusting them for any anticipated changes such as capital improvements,loan interest and other interests,new funding sources or expiration of previous funding sources,sales fluctuation,various programs undertaken by company,etc. The next step is to have detailed knowledge of amounts and date of upcoming cash outlays including rent,inventory control,office supplies,debt payments,maintenance charges,cash dividends,etc. These cash flow projections should be updated regularly.

  • Improve the cash flows by encouraging people or company,who owe you money,to pay it as soon as possible and delaying cash outlays.

  • Concentrate more on the problem of timing of cash flows. This problem may occur either due to cash surpluses or due to cash shortages. Cash surpluses arise when income is received earlier and has to be used in the form of payment of expenses.In other words,it happens when the cash receipts exceeds the cash expenses.While,cash shortages arise when expenses come in before the income and company unable to pay its bills until the cash is received. In other words,it arises when cash receipts falls short of the cash expenses.So,a business suitable strategy needs to be designed in order to deal with such a problem.

    • For handling cash shortages,a firm may:- (i) obtain loans from a bank or an individual; (ii) speed up the collection of receivables (money owed to you); (iii) have fund raising events or campaigns; (iv) finance the purchase of equipment by leasing it out or paying for it over time or liquidate investments and delay payments to suppliers and creditors.

    • For handling cash surplus/profits, a firm may :- (i) earn investment income by making short term investments in financial market; (ii) utilize these during lean times; (iii) buy supplies on sale that you will use over the course of the year.

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Accounting Standards for Cash flows by Institute of Chartered Accountants of India
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