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Cash management is an essential, yet often neglected, component of business management. We have all heard the statement that "most companies do not fail from lack of profit, but from lack of cash". It is also true that a period of dramatic sales increases will most likely be a company's most profitable, but will also likely be the period of greatest cash flow needs. Although this may at first impression seem like a paradox, it is inevitable due to the cash flow cycle of a business. It is this cycle of cash - from investment in inventory and payment of overhead, conversion into accounts receivable via sales, and ultimate conversion into cash through collection of receivables - that must be planned for. As a company expands, this cycle increases, with more cash being tied up at every level.

Current vs. Future Cash Needs An analysis of working capital and current cash needs does not provide an indication of the company's future cash flow needs. A working capital analysis will assess the company's ability to pay its existing liabilities. It does not analyze variables that greatly impact future cash flow such as:

• An increase in sales
• A change in the customer payment terms
• The funding requirements for equipment needed for expansion
• A change in vendor payment terms or discount policies
• The cash flow needs for adding a new product line or expanding into a new market

This information can only be analyzed through the preparation of a cash flow projection. The purpose of a cash flow projection is to assess the funding requirements needed for the expected level of operations and analyze the impact of proposed business decisions on cash flow.

Preparing a Cash Flow Projection The cash flow projection process begins with a twelve-month sales projection. The sales department should be primarily responsible for the development of the sales projections, and these projections can be tied-in with individual sales goals and incentive compensation. Based on anticipated sales, a twelve-month expense projection needs to be developed. Expense budgets should be primarily developed and agreed upon by the person(s) responsible for controlling those expenses. The resulting budgets can be tied in with departmental goals and incentive compensation as well. Other transactions affecting cash flow also need to be projected, such as capital asset purchases and shareholder distributions. Based on a beginning balance sheet and assumptions about the company's payment policy and collection history, the projected revenues and expenses can be converted into a twelve-month cash flow projection. Although this conversion process from revenue and expense projection to cash flow projection may sound complicated, there are spreadsheet templates available which simplify this process and produce great cash flow projection reports. These reports should include:

• Monthly cash balance
• Monthly line of credit borrowings and the adequacy of the collateral borrowing base
• Monthly balance sheet projections
• Monthly interest expense projections based on borrowings
• Monthly tax expense based on projected income

Utilizing Projections as a Management Tool Once a cash flow projection has been prepared, it will provide answers to questions such as "do we need to increase our line of credit" and "what if we negotiated extended payment terms from key vendors." By anticipating cash flow shortfalls before it's too late, "surprise" last minute requests for increased borrowing limits can be eliminated and vendor purchase discounts won't be missed.

Incorporated into a monthly reporting format, the monthly projections will also provide the company with a benchmark or framework from which to gauge actual monthly performance. When the company management team is involved in establishing the budgets and works toward achieving these goals, this monthly budget vs. actual comparison can be incorporated into a performance measurement tool.

Conclusion Cash flow projections give management the power to predict the future and the ability to change it before it's too late. Cash flow planning and financial projections are an essential tool in the decision making process and play a vital role in planning the future development of the company.

PREPARING FOR THE YEAR 2000

It is the morning of January 1, 2000 and you turn on your computer. You may be amazed at what appears on the screen. Is your business ready for the year 2000? While you may believe that you will not be affected, adequate preparation should be taken to ensure that you computer system will handle the new millennium successfully.

The year 2000 computer problem resulted from the need to save computer memory. Computer programmers used two digits rather than four digits to delineate the year. Consequently, on January 1, 2000, millions of computers will treat 01/01/00 as January 1, 1900. This could have a substantial effect on accounts receivable and accounts payable schedules, payroll and employee benefits calculations, forecasting, inventory tracking, as well as other important accounting items for your business.

This dilemma could occur in different areas including mainframes, software, local area networks, personal computers, and credit card processing equipment. For instance, you may have a new computer system, but applications running on the system may not be year 2000 compliant. Therefore, this problem presents a substantial threat directly and indirectly to all types of businesses.

Although all of your year 2000 problems may appear to be solved, you should also be concerned with possible difficulties within the systems of your customers, suppliers, or partners. They may cause incorrect billings and shipments, for example, and could dramatically affect your business. Furthermore, other problems could exist when banks treat loans which were paid off years earlier as still outstanding, and taxes paid and valid licenses appear not to be paid or are shown to have expired.

Another important concern is with data which is exchanged electronically. A bug on one business' system could very easily affect another business' year 2000 compliant system. Building owners should be particularly concerned with their building's alarm systems, elevators, and air conditioning.

Despite these consequences, many businesses believe that this is only a problem for large corporations. However, most large corporations have already been working to solve this problem using full-time employees. Smaller and medium-sized businesses may encounter the most problems as they are dependent on computer consultants and software vendors.

As a result, it is paramount that adequate steps be taken to ensure year 2000 compliance. Tests should be administered to identify whether potential problems exist. If problems are found, they should be prioritized by their importance to your business. Management should also evaluate the cost and length of time necessary to solve these problems. Resolving these problems may not only involve replacing non-complaint software, but also extensive reprogramming. Reprogramming is more time consuming, expensive and will be inclined to more errors than replacement. In addition, agreements with vendors or computer service providers should be carefully examined to determine liability. Given the enormity of the year 2000 problem and its far-reaching effects, it is time to develop an action plan to assess and correct the problem for your company.

To address your company's year 2000 issues, please contact us and we will work with you and our computer consultants to ensure your year 2000 compliance.

BUSINESS EQUIPMENT: Purchase Versus Lease?

Once your business has made the decision to acquire additional equipment, the next decision to consider is whether to purchase or lease the equipment. While total cost is the factor most often considered by businesses, there are a number of additional factors that should be considered in the purchase versus lease decision. The following is a short list of factors to consider in your purchase versus lease decision:

COST:

Purchasing equipment will generally be less expensive than leasing over the lease term. This cost difference will vary significantly based on the sales price established for the purchase or lease, length of financing or lease term, interest rate charged, cost of excess usage by lessee, tax deductions, and other terms related to a purchase or lease agreement. Since the equipment lessor bears significant risk that the value of the equipment at the end of the lease will be less than its remaining economic cost, terms that reduce this risk tend to reduce the cost difference between purchasing and leasing. If the lease contains an option-to-purchase clause at the end of the lease, the estimated fair market value of the equipment and the option-to-purchase price will need to be considered as part of your overall cost comparison. Finally, the various cash payments and cash benefits from tax deductions should be discounted to determine the actual present value cost of the purchase or lease at the date of acquisition.

FINANCIAL IMPACT:

Equipment purchased with cash will eliminate the cost of interest and financing costs. However, since the cash will not be available for other business expenses or opportunities, the "interest-free" use of the cash should be compared to the rate of return the cash would earn in another investment, the cost of additional financing that may be incurred if the cash is unavailable for other business expenses, or the cost of "lost opportunities." Additionally, the use of cash to fund the purchase of a long-term asset will reduce the business's liquidity and current ratio (current assets divided by current liabilities) which could violate current ratio requirements set by lenders or suppliers. Financing your purchase will also require analyzing your current lender and supplier debt covenants to make sure that the additional financing does not violate any established covenants. A purchaser may find that the cost of financing from the seller is cheaper than the cost of financing from a lending institution or the internal cost of using available cash. While many leases and their corresponding lease obligations must be recorded on the balance sheet as "capital leases" for financial statement purposes, under certain circumstances a lease may qualify as a noncapital lease. A noncapital lease will allow the lessee to acquire additional equipment without incurring additional debt or violating current ratio and debt covenants.

OWNERSHIP:

A primary advantage to a purchaser is ownership. Ownership will provide the purchaser full control over the equipment (subject to any applicable financing restrictions) including decisions such as insurance, maintenance, modification, rate of usage, sale/exchange, and sublease. A primary disadvantage to a purchaser is the risk of loss or obsolescence. Although generally covered by insurance or warranty, the purchaser will bear all risk of loss due to destruction or down time for a major repair. In today's rapidly changing, innovative and technical business environment, the useful life of purchased equipment may be shorter than anticipated. The equipment purchaser may be forced to sell the obsolete equipment at a substantial loss. Meanwhile, a lessee will be able to avoid obsolescence by switching to newer equipment at the end of the lease and may be able to shift other risk of loss to the lessor.

TAX DEDUCTIONS:

Purchasing and leasing have significant differences for tax purposes. When a business purchases equipment the purchase price must be capitalized and depreciated over the appropriate recovery period, usually five to seven years. A purchaser may qualify to make an annual one-time election to currently expense up to $19,000 of the cost of new equipment purchased during the year, often referred to as a "Section 179 Election." When a business leases equipment, the lease payments are currently tax deductible when paid (by a cash basis taxpayer) or accrued (by an accrual basis taxpayer). Purchasing is probably more advantageous when the lease term is equal to or greater than the depreciation recovery period, or the $19,000 Section 179 Election will be utilized. If the lease term is shorter than the depreciation recovery period, or the $19,000 Section 179 Election can be utilized by other purchases, leasing is probably more advantageous.

In summary, purchasing equipment will prove to be cheaper if the cash outlay will not earn the business a greater rate of return on another investment and if the equipment has a long useful life. While financing a purchase will increase the total cost, the benefits of ownership will still be available to the purchaser. Leasing, while potentially the highest cost of all the options, will generally require a smaller initial cash outlay, may be financed off the balance sheet, and provides the business better protection against obsolescence. Finally, the current tax expense for lease payments needs to be compared to the depreciation and $18,000 Section 179 Election available to purchaser. Only after considering all of the above factors can a business make the decision to purchase or lease their equipment. If you are considering the acquisition of additional equipment and would like assistance, please feel free to give Berntson Porter & Company a call. We would be glad to assist you.

IS IT TIME FOR SPRING CLEANING?

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CASH MANAGEMENT - use vendor discounts to maximize your rate of return

Should you take a vendor's discount? That depends. If your company's funds are in a non-interest-bearing account, then discounts should always be taken when funds are available. When the funds would otherwise be earning interest, or when the funds would need to be borrowed, a simple formula can help you gauge if a discount is worthwhile.

% Cash Discount /Date for Net Payment - Date for Discount Pay x 365 Days

The computed annual rate can be compared to the interest rate that could be earned if the funds were left in an interest-bearing account, or the interest rate that would have to be paid on borrowed funds.

Example: A typical discount offered by vendors is a 2% discount if paid within 10 days, otherwise pay the full amount in 30 days. This converts to an annual rate of 36.5%. Unless the company can earn an interest rate higher than this elsewhere, the discount should be taken.

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THE TRUE COST OF PREVENTABLE ERRORS -a new perspective on the cost of errors

Consider the effect on profitability when someone works unnecessary overtime, drives a company vehicle a few unnecessary miles, fails to collect an overdue account, subscribes to unused journal subscriptions or needlessly pays too much for supplies. The impact of an undesirable action is much more than the additional dollar cost of that action. Any decision which leads to additional work or additional costs that does not add value in the minds of your customers, or is not required by law, should be scrutinized.

The added cost of these actions should be viewed in terms of additional revenue needed to pay for the cost.

For example, if the cost of the action is $100, and the company's net profit after all variable costs is 18%, then the sales dollars required to break even on the added cost is $556. If we assume that all costs are variable for a company over a given revenue range, the impact of an unnecessary action is even more dramatic. For example, if the net profit is 3%, then the sales dollars required to cover an additional $100 cost is $3,333. You could do all the work necessary to sell an additional $3,333 of products and make absolutely nothing.

Most business owners have never looked at cost from this perspective. Using this perspective as a tool in analyzing costs will assist businesses in improving systems to ensure that preventable errors are minimized.