Module:

Entrepreneurship
Dr Tamer Karam
Essentials of Entrepreneurship and Small
Business Management
Eighth Edition
Section 3: Launching the Business

Chapter 11
Managing Cash
Flow

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Learning Objectives (1 of 2)
1. Explain the importance of
cash management to a
small company’s success.
2. Differentiate between cash
and profits.
3. Understand the five steps
in creating a cash budget.

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Learning Objectives (2 of 2)
4. Describe fundamental principles involved in
managing the “big three” of cash management:
accounts receivable, accounts payable, and
inventory.
5. Explain the techniques for avoiding a cash crunch
in a small company.

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The Importance of Cash
• “Everything is about cash – raising it, conserving it,
collecting it.” ~ Guy Kawasaki
• Common cause of business failure: Cash crisis!
• It is possible for a business to earn a profit and still go
out of business by running out of cash.
– Valley of death

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Figure 12.1 The Valley of Death

Source: Yoshitaka Osawa and Kumiko Miyazaki, “An Empirical Analysis of the Valley
of Death: Large Scale R&D Project Performance in a Japanese Diversified Company,”
Asian Journal of Technology Innovation, vol. 14, no. 2, 2006, pp. 93–116.
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Cash Management (1 of 2)
• American Express Open Small Business Monitor
study:
– 52% of small business owners experience
problems with cash flow.
– Their biggest cash flow concern is the ability to pay
bills on time.

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Figure 12.2 Small Business Owner's
Rating of Their Companies' Cash Flow

Source: Based on data from Wells Fargo Small Business Index, 2nd
Quarter 2014, p.11.
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Cash Management (2 of 2)
• Cash management:
– The process of forecasting, collecting, disbursing,
investing, and planning for the cash a company
needs to operate smoothly.
• Young and growing companies are “cash sponges.”
• Know your company’s cash flow cycle.

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Cash and Profits
• Cash ≠ profits.
• Profit is the difference between a company’s total
revenue and total expenses.
• Cash is the money that is free and readily available to
use.
• Cash flow measures a company’s liquidity and its
ability to pay it bills.

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Figure 12.4 Cash Flow

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The Cash Budget
• Cash budget:
– A “cash map” that shows the amount and the
timing of a firm's cash receipts and cash
disbursements over time.
• Predicts the amount of cash a company will need to
operate smoothly.
• Helps to visualize a company’s cash receipts and
cash disbursements and the resulting cash balance.

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Preparing a Cash Budget
• Five steps:
1. Determining an adequate minimum balance.
2. Forecasting sales.
3. Forecasting cash receipts.
4. Forecasting cash disbursements.
5. Estimating the end-of-the-month cash balance.

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Determine an Adequate Minimum
Cash Balance
• Step 1
– The most reliable method of deciding the right
minimum cash balance is based on past
experience.

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Forecast Sales (1 of 2)
• Step 2
– The heart of the cash budget.
– Sales are ultimately transformed into cash receipts
and cash disbursements.
– Cash forecast is only as accurate as the sales
forecast from which it is derived.

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Forecast Sales (2 of 2)
• “Lumpy” or seasonal sales patterns are common.
– 15% to 18% of wine and spirits shops’ annual
sales occur between December 15 and 31.
– 40% of toy sales take place in last 6 weeks of the
year.
• Prepare three sales forecasts:
– Pessimistic
– Optimistic
– Most Likely

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Sales Forecast for a Start-Up
Example:
Number of cars in trading zone 84,000 autos
× Percent of imports × 24 %
= Number of imported cars in trading zone 20,160 imports
Number of imports in trading zone 20,160 imports
× Average expenditure on repairs and maintenance × $485
= Total import repair sales potential $9,777,600
Total import repair sales potential $9,777,600
× Estimated share of the market × 9.9%
= Sales estimate $967,982

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Forecast Cash Receipts
• Step 3
– Record all cash receipts when the cash is actually
received (i.e. the cash method of accounting).
– Determine the collection pattern for credit sales;
then add cash sales.
– Monitor closely: Slow and non-payers.

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Figure 12.5 Probability of Collecting
Accounts Receivable

Source: Based on data from the Commercial Agency

Section, Commercial Law League of America, 2011.
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Forecast Cash Disbursements
• Step 4
– Record disbursements when you expect to make them.
– Start with those disbursements that are fixed amounts
due on certain dates.
– Review the business checkbook to ensure accurate
estimates.
– Add a cushion to the estimate to account for “Murphy’s
Law.”
– Don’t know where to begin? Try making a daily list of
the items that generate cash and those that consume
it.

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Figure 12.6 Cash Flow Concerns
among Small Business Owners

Source: Holly Wade, Small Business Problems and Priorities,

National Federation of Independent Business, August 2012, pp. 13–14.
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Estimate End-of-Month Balance
• Step 5
– Take Beginning Cash Balance ...
– Add Cash Receipts ...
– Subtract Cash Disbursements
– Result Is Cash Surplus or Cash Shortage (Repay
or Borrow?)

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Benefits of Cash Management (1 of 2)
• Increase amount and speed of cash flowing into the
company
• Reduce the amount and speed of cash flowing out
• Make the most efficient use of available cash
• Take advantage of money-saving opportunities such
as cash discounts

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Benefits of Cash Management (2 of 2)
• Finance seasonal business needs
• Develop a sound borrowing and repayment program
• Impress lenders and investors
• Provide funds for expansion
• Plan for investing surplus cash

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The “Big Three” of Cash Management
• Big Three:
1. Accounts receivable
2. Accounts payable
3. Inventory
• The Big 3 interact to create a company’s cash
conversion cycle:
– The length of time required to convert inventory
and accounts payable into sales and accounts
receivable and finally back into cash.

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Figure 12.7 Amazon’s Cash
Conversion Cycle

Source: Based on data from “The Cash Conversion Cycle,” Forbes, March 10, 2012,
http://www.forbes.com.
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Accounts Receivable
• About 90% of industrial and wholesale sales are on
credit, and 40% of retail sales are on account.
• Survey of small companies: 74% have accounts
receivable outstanding for 60 or more days.
• Remember: “A sale is not a sale until you collect the
money.”
• Accounts receivable goal: Collect your company’s
cash as fast as you can.

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Establish a Credit and Collection
Policy
• Screen credit customers carefully.
• Establish a firm credit-granting policy.
• Send invoices promptly.
– Cycle billing
• When an account becomes overdue, take action
immediately.

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Accelerating Accounts Receivable
• Ensure that invoices are accurate and timely.
• Include a description of the goods or services
purchased.
• Ensure that invoices match purchase orders or
contracts.
• Highlight the balance dues and due date.
• Include contact information in case customers have
questions.
• Use a security agreement.
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Accounts Payable
• Stretch out payment times as long as possible
without damaging your credit rating.
• Verify all invoices before paying them.
• Negotiate the best possible terms with your suppliers.
• Be honest with creditors; avoid the “the check is in the
mail” syndrome.
• Schedule controllable cash disbursements to come
due at different times.

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Inventory
• Monitor inventory closely; it can drain a company’s
cash.
• Avoid inventory “overbuying.”
– It ties up valuable cash at a zero rate of return.
• Arrange for inventory deliveries at the latest possible
date.
• Take advantage of discounts:
– Quantity discounts
– Cash discounts

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Figure 12.8 A Cash Discount

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Table 12.8 Cost of Forgoing Cash
Discounts
Cash Discount Cost of Forgoing the Cash Discount
Terms (Annually)
2
, net 30 37.25%
10
2
, net 40
10 24.83%

3
, net 30 56.44%
10
3
, net 40 37.63%
10

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Avoiding the Cash Crunch (1 of 4)
• Barter
– Consider bartering, exchanging goods and
services for other goods and services, to conserve
cash.
§ More than 500 barter exchanges operate across
the United States.

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Avoiding the Cash Crunch (2 of 4)
• Trim overhead costs:
– Ask for discounts and “freebies”
– Conduct periodic expense audits
– Lease rather than buy
§ Operating lease
§ Capital lease
– Avoid nonessential cash outlays
– Buy used or reconditioned equipment
– Hire part-time employees and freelancers

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Avoiding the Cash Crunch (3 of 4)
• Outsource
• Use e-mail rather than mail
• Use credit cards for small purchases
• Negotiate fixed loan payments to coincide with your
company’s cash flow
• Establish an internal security and control system
• Develop a system to battle check fraud
• Change shipping terms

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Avoiding the Cash Crunch (4 of 4)
• Start selling gift cards
• Switch to zero-based budgeting
• Be on the lookout for employee theft
• Keep your business plan current
• Build a cash cushion
• Invest surplus cash
– Money market account
– Zero-balance account

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Conclusion
• “Cash is King”
• Cash and profits are not the same.
• Entrepreneurial success means operating a company
“lean and mean.”
– Trim wasteful expenditures.
– Invest surplus funds.
– Plan and manage cash flow.

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