Managing Cash Flow

38 Managing Cash Flow—Receipts and Disbursements
may have a positive cash flow and a profitable operation over a short-term period,
while at the same time developing financial indications that foretell future problems.
In this case, an increase in accounts receivable (uncollected cash) and fixed
assets without sufficient cash reserves to handle them forced a delay in the payments
of accounts payable and accrued expenses.
Cash Flow Costs
Cash flow problems can cause operational problems, which will ultimately result
in real costs to the business. These costs can be direct cash costs—bad debt losses
caused by failing to follow up on overdue receivables, storage and carrying costs
of excess inventory, operating and insurance costs associated with excess fixed
assets, and interest costs on borrowings necessitated by the cash flow problems.
Or they might be indirect business costs, such as vendors refusing to deliver, an
inability to secure additional financing for worthwhile long-term investments
because of too much short-term borrowing, inadequate space caused by too much
inventory or fixed assets, an inability to service customers adequately, and the
like. Solving the company’s cash flow problems normally accomplishes more than
helping avoid financial embarrassment—it also helps to increase company
earnings.
For instance, the Jack B. Nimble Company had a large increase in accounts
receivable, which created the need to borrow money to get out of the cash flow
deficit and allow for the timely payment of obligations. In this situation, we
should look at the cost of borrowing about $800,000 to get payables down to an
acceptable position and to continue to pay off other liabilities; and another
$125,000 or so to pay off the line of credit and build up operating cash reserves. At
a 9 percent interest rate, the cost per year would be nearly $85,000—money that
could be better used in the business, particularly in a time of substantial growth
and expansion. Had Jack held his investment in accounts receivable and fixed
assets in line with his sales growth, which would have reduced the need for incurring
debt, the interest cost saving would have flowed straight to the bottom line
and his cash crisis could have been averted.
Operationally, it is necessary also to look at the quality of the receivables—
that is, are they collectible or has Jack merely buoyed up sales by selling to less
desirable credit-risk customers at less than favorable prices? Also, while borrowing
provides the cash necessary to meet cash commitments and avoid a cash flow
crunch in the short term, it does not solve the cash flow problem caused by burdensome
investments. Borrowing, in this case, is only an expensive, and shortterm,
crisis delayer. In our scenario, Jack has avoided some of his cash flow
problem by using vendors to finance his extra investment. He has thereby temporarily
avoided the full cost of borrowing and its related interest costs. But has
he protected his bottom line? No, because the excess investment is still a cash flow
problem with an effect on earnings. He has an opportunity cost of lost potential
earnings and growth. That is, he has lost prospective use of and earnings on cash,