By Keith Blackman, CPA* - Principal

Quite often, companies, especially smaller, emerging entities will gloat with pleasure over their high margins and declare that all is well with the business. Indeed, all may be well with the business model itself but what about sustainability of the business as a whole? More specifically, will there be enough cash to ensure that the company can achieve its strategic objectives or even simply to meet its daily, weekly and monthly liquidity needs? Regardless of a company's profitability level, an inability to pay its recurring bills, to fund payroll, or to fulfill its tax obligations will lead to the demise of the company.

Cash Flow for short-term and everyday needs

Experienced CFOs know that "cash is king" and that one must keep the proverbial eye on the prize, cash, at all times. Working with or without a treasury manager, a CFO must have a handle on the timing of inflows and outflows of the cash cycle in order to be able to identify low cash flow periods. This allows the CFO to be proactive in devising solutions for addressing funding sources, or deciding if and when an increase in the collections effort is warranted. It may even become necessary to negotiate new or extended payment terms with vendors and service providers. Oftentimes a seasoned CFO will need to lead or guide these discussions in order to minimize the impairment of any strong relationships between the company and its important creditors.

However, vendor and service provider payments form only one piece of the puzzle in understanding and calculating cash outflows. Attention must also be given to the timing of payouts for salaries and wages, employee benefits, taxes, debt servicing and other payments that can potentially gobble up most or all of the disbursement pie. Failure to meet any one of these obligations could put the company in serious jeopardy.

Effective short-term cash management requires cross-functional support. While the CFO will be the person ultimately responsible for ensuring that the company can meet its liquidity needs, a strong CFO can engage other department heads who can provide valuable input when addressing projected uses of cash. Cash flow projections and forecasts can then be prepared using this information, along with calculations on the probability and timing of cash inflows.

Cash Flow for long-term and strategic needs

Longer-term cash flow forecasts and cash flow budgets are derived from the company's annual budgeting process and from its long-term strategic plans.   Effectively managed organizations will usually have a one-year plan, also known as its annual budget, in addition to five-year and ten-year strategic plans. Similarly, the CFO is responsible for the preparation of annual, five-year and ten-year cash flow forecasts that aim to tell the story of not IF the company can achieve its goals, but HOW it is going to do so. These long-term forecasts usually include spending on capex and other capital-intensive resources needed for expansion, diversification or strategic posturing, along with potential sources and structures of funds to meet these requirements.  

Cash flow forecasts form a dual purpose of not only providing insight into how a company can achieve its long-term liquidity needs, but also the strategic efforts that should be pursued in relation to all options available to the company. For example, should the company build a cash war chest in order to fund its needs from internally generated cash; should it engage outside lenders for term loans, or lines of credit, or both; should it raise capital through equity, and if so, whom should it partner with - venture capitalists, private equity firms, existing owners, others?

Such decisions are based on careful calculations of the cost of these sources of funds. The CFO has to take into consideration the company's weighted average cost of capital (WACC), prevailing interest rates, lender fees, owners' expected and anticipated rate of return on invested capital, existing debt load, and many other factors that a CFO, as strategic partner to the CEO or business owner, must incorporate into the decision-making process. Experienced CFOs already know how to do this.

*Licensed Certified Public Accountant (CPA) in the State of New Jersey