Why Cash is Always King! – Part IV

In the past, I have heard some accounting people say that capital spending should not exceed your prior year depreciation expense.  When I think about that rule of thumb, I am not sure what difference it really makes.  There are many aspects to capital spending, some related to Sec. 179 of the Internal Revenue Code.  Under Sec. 179 some investments can be expensed in the current year.  However, you should always consult your CPA/tax preparer before making any capital investments based on Sec. 179.  The lease versus purchase is sometimes a complicated decision and is best left to a discussion with your CPA.

For any business owner, deciding whether or not to make a capital investment is based on two things.  The first is, does the company have the money or access to money that will allow the purchase?   Second, will it produce revenue directly or indirectly?  Is it a replacement item (your delivery truck is on its’ last leg and must be replaced) or an expansion (your current delivery truck can’t get around to all the customers on a timely basis).  When I was growing up, my father, an attorney, always drove a new car. He believed that clients didn’t want to hire an attorney who didn’t look successful.  Is that true anymore?  Do we base our decisions on how successful someone looks?

For larger companies, there should be a formalized capital projects processes and procedures. For instance , a request can be created, either on paper or electronically, for the capital item.  Information attached to the request ideally would  contain at least 3 bids/quotes.  Sometimes, the item is so specialized that there may be only one source for it.  The bid is then circulated to a group of approvers, generally the controller, CFO, President, COO, etc.  This keeps all members of senior management in the loop.  Once it’s approved, then a purchase order should be prepared. But all of the processes and procedures pale in comparison to making the wrong decision about a capital investment.  Strategic  capital spending is critical to the success and survival of any business.  The most important part is the justification process where there is a dialogue that thoroughly explores the need for the investment.  If you want more information on setting up a capital projects procedure, send me an e-mail at judith.sherling@cpa.com.

In closing my series on WHY CASH IS KING! I want to emphasize one thing.  You cannot save yourself into a profit.  Too many controllers and other management level people turn themselves in to penny pinchers.  That is not what cash flow management is about.  It’s about MANAGING the money available and making sure that dollars invested in inventory and fixed assets have been deployed to maximize income.  Remember, as controller or owner, you should always be able to answer the question ‘how much am I owed?’ and ‘how much do I owe?’.

Next week, I’ll start my newest series called ‘THINK LIKE A CONSULTANT – HOW TO STREAMLINE YOUR COMPANY FROM THE INSIDE’. 

Stay tuned.

Why Cash is Always King – Part III

Continuing on from Part II of ‘Why Cash is Always King’, let’s discuss what is referred to as ‘obsolete’ or ‘unsalable’ inventory.

Using the ‘inventory turns’ method of analysis, hopefully you have some idea of how you are doing. Buying inventory sometimes presents significant challenges, especially if you are in a highly volatile market. Volatile markets are often a challenge for companies that buy and sell commodities. For instance, a wholesaler providing milk and eggs to grocery stores faces prices changing every day. Sometimes those changes can be significant. National drug store chains sell gallons of milk as loss leaders. The small grocery down the road, they’re probably selling on the high side of the milk market. But no one wants to be left with unsold milk and eggs at the end of the day. Knowing how much to buy each day or each time can be key to reducing losses related to unsalable inventory (outdated milk and eggs).

Let’s look at a more common small to medium size business challenge. For instance, let’s say you are the Controller at ‘My Doll Shop’. Last year, Doll ‘X’ was a very sought after item and purchasing couldn’t even secure all the inventory you needed. However, a few weeks after Christmas purchasing had the opportunity to buy up a significant number of Doll ‘X’. But this year, little girls have their hearts set on ‘Doll ‘Y’. No one is interested in last year’s big hit, Doll ‘X’. My Doll Company is now the proud owner of some obsolete or slow moving inventory. One good thing about dolls, they are not perishable. They won’t rot on the shelves. But, you have dollars locked up in those dolls. Too many owners and managers simply ignore the problem because they have much more pressing issues to deal with. But if that obsolete and slow moving inventory isn’t dealt with, it takes up space. And, if the company is waiting for the Doll ‘X’ rage to come around again, they are probably in denial.

First, someone in your company, if not you, should have the task of addressing obsolete inventory and how to move it. Can it be sold on E-Bay? There’s work involved but E-Bay gets you a worldwide audience. Could you have a really big sale? I don’t have all the answers to this problem but ignoring it will certainly translate into losses at some point. Manage your inventory every day!

Oh, by the way, if you are the newly hired controller, and you’re working for a company that carries inventory, one of your first objectives should be to familiarize yourself with the inventory and, I would also recommend that at the end of the next accounting period (hopefully at the end of the month) you make sure that a physical inventory is scheduled. Once the inventory is completed, it should be compared with the book inventory to determine any gains or losses. And, very importantly, find out how much of that inventory is obsolete or unsalable. It’s far too often a neglected area of the company’s working capital investments.

In Part IV, the final post on CASH, we will look at FIXED ASSETS and the perils of both spending too much or too little.

Questions? Please feel free to comment, ask questions, or suggest other topics.

Why Cash is always King – Part I

ProfitHaving worked most of my career in the agribusiness field, I have found the ‘Limiting Factor’ theory applicable to many areas of business.  The ‘Limiting Factor’ is a simple concept.  A plant needs many different types of nutrients (food) to grow.  You can supply all the nutrients it needs, except one.  Without that one, the plant cannot grow, in spite of everything else having been done correctly.  So all the other things you did right, they do not count!  The same with cash.  No money, nothing else really matters.

Even large businesses struggle with Working Capital needs

If the entrepreneur is the heart of the business, cash is the blood.   Lack of working capital is not just a start-up issue.  It confronts owners everyday, in spite of our low interest rate environment.  Where are the money ‘pits’ that working capital is usually trapped?

  • Inventory
  • Accounts Receivable
  • Fixed Assets

The pits mentioned above are, by no means, all of them but are generally the largest ones.  In future posts, I’ll talk about how a business can do a better job of managing their liquidity.  Ask yourself, is your banking arrangement facilitating your ability to grow your business, meet payment deadlines and invest in the future?  Just because you’ve done business with them for the last ten or twenty years does not mean you should be comfortable.  Do you have just one lender?  Should you?

The Cash Conversion Cycle

Simply put, the Cash Conversion Cycle is a measurement of how long it takes to convert the dollar invested into inventory back into cash.  Accounts payables affects the ratio as well.  You can probably find a more detailed explanation by googling it.  Many business owners understand that money tied up in Accounts receivables and inventory must be freed up as quickly as possible to continue financing the business.  Obsolete or damaged inventory takes up space and is no longer worth its original cost.  Accounts Receivables moving well past terms are problematic and may indicate you won’t be turning the receivable into cash as soon as you had expected.  A/R and Inventory are areas that owners and managers must be vigilant about.  Fixed Assets present a somewhat different issue.  There are really two types of assets – those that can directly produce income and those that do not.  For instance, a new (or used) delivery truck in addition to the one you have is an expansion.  If the truck has been added to service new accounts, and generate new or additional business, then that asset has income producing properties.  However,a fancier car for a manager or owner rarely translates into additional, measurable  income for the company.  Unless the company can clearly afford such a fixed asset investment, non-income producing asset expenditures should be avoided.

Unless your company is rolling in money, paying attention to cash flow should be a top priority.  More on this subject in future posts.

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