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The following example shows the impact of implementing these practices on a hypothetical company:
Page 41
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BEFORE improvements are introduced
The company generates good profits but the directors are unable to take their bonuses due to poor cashflow: Fixed assets (equipment,
cars, etc) cars, etc) Work in progress Stock
Debtors Creditors Bank overdraft £75,000 £100,000 £10,000 1175,000 (1125.000) (£25,000) Bonuses owed to directors (125,000) Net current assets 1110,000 1185,000 inc 175,000 fixed assets Share capital £10,000 Profit-and-loss account £175,000 The following assumptions have been made:
z The company has three months' work in progress;
• Debtors take an average of 60 days to settle; • The bank overdraft is at its maximum of £25,000; • The company has bought a van for 115,000 cash;
• The company only requires half the parts currently held;
Creditors are only paid when cash is collected from debtors.
Action The company takes steps to improve its management of cash flow, namely: 1i Invoice WIP at the end of each month—this would reduce the amount under WIP by £67,000 down to one month (taking it to just 133,000—see below). Debtors would increase by 167,000 (from £175,000 to £242,000). There would be no immediate effect on cash;
Chase outstanding invoices, le tighter credit control, with the goal of reducing debtors to 45 days (as opposed to 60 days). This would reduce the amount outstanding by £60,000 (taking debtors down from £242,000 to £182,000), which would have a prompt impact on cash flow—see right;
Take all settlement and other available discounts from suppliers—as the company pays creditors when it col
lects from debtors, the time taken to pay creditors would also reduce by 15 days. Although creditors would be paid earlier (an additional cash outflow of £30,000) the business would benefit from early settlement discounts; Refinance the new van on hire purchase, providing £15,000 cash;
Dispose of excess stock to generate, say, £5,000 cash.
The combined effect of these moves is shown in the revised balance sheet below:
AFTER improvements are introduced
The bank account is now 225,000 in credit--sufficient to pay the directors' bonuses' fixed assets (equipment, cars, etc) £75,000 Work in progress £33,000 Parts £5,000 Debtors £182,000 Bank balance £25,000 Creditors (£95,000) Hire purchase (£15,000) Bonuses owed to the directors (£25,000) Net current assets £110,000 (£185,000) Share capital £10,000 Profit and loss account £175,000 1185,000 inc 175,000 fixed assets
Although there may be other issues, such as future expansion, which make urgent demands on a firm's cash resources, the example above illustrates the benefits of good cashflow management.