Cash Flow OPI

One-Point Insights [OPI] are the quickest way to learn and understand one key management topic at a time. A brief and simple analysis of Cash Flow that explains what it is, how to calculate it, and how to maintain consistent Positive Cash Flows as you manage your company.

This OPI aims to reinforce how cash moves through your company, how it increases available cash, and what depletes it. Once Cash Flow is clearly understood, you will increase your ability to maintain consistent positive cash flow and make the right decisions to keep your operations cash-healthy and extend your Cash Life-Line to deal with difficult times.

What is Cash Flow?

The normal situation within a company is where the cash inflows during a period are higher than the cash outflows during the same period. When cash inflows are greater than outflows, you have Positive Cash Flow. However, having Positive Cash Flows is usually due to well-planned management of cash inflows and outflows and does not necessarily mean the company is profitable.

Image 1 shows an actual real-case example of poor Cash Flow management; only 6 out of 23 periods have Positive Cash Flow causing financial and operational strain across the company; 74% of the time, the company was short on cash.

Image 1 - (image from Argo EnGen™ business diagnostics software, Celeran Enterprise Genetics, Inc.)

Cash Inflows come from the normal SALES operation of a company in the form of cash or Account Receivable when collected, from the Sale of INVENTORY on hand, and PROCUREMENT payment terms. We will examine this in detail later.

What is Operating Cash Flow?

Operating Cash Flow is the amount of cash generated by a company's normal business operations and indicates whether a company can generate sufficient positive cash flow to maintain and grow its operations.

Cash Flow Visual Water Analogy

Imagine the flow of cash as if it was a flow of water; you open the faucet, the water level drops, and you never want to run out of water. On the other hand, if more water is dripping INTO your water reserve, then your water level increases. However, if the water outflow rate is greater than the inflow rate, you WILL run out of water, and without it, your operation stops.

I Imperative to keep an eye on the Cash Flow Life-Line, which I represents the number of days a company can survive I without any cash inflows.

This is a graphical representation of the inflows and outflows of cash in the operation of a business using water for the analogy.[image 2]

Image 2 - Cash Flow Chart from the book MAV, Balance Sheet & Cash Flow by Author Ruben Martinez-Vera, Ph.D.

The formula for Calculating Cash Flow

The equations that follow are basic accounting math displayed in a simple way to understand Cash Flow logic [image 3]. In its reduced form, the first equation states: Assets = Liabilities + Owner’s Equity. Because Assets and Liabilities both have Current and Non-Current components, this simple equation can be expanded to show more detail. In the second equation, notice how Assets are broken down into two components; Current and Non-current, the same for Liabilities; Owner’s Equity remains the same.

Image 3 – Cash Flow Image by Celeran Enterprise Genetics, Inc.

In the third row, we are going to break down the LEFT side of the equation only, Current Assets into even more detail: CASH, Accounts Receivable and Inventory, and Non-Current Assets remain the same.

Now with this level of detail, we can rearrange the equation to isolate CASH in the fourth row. This is the equation we can use to understand CASH FLOW.

Refresher on how to rearrange formulas: see the APPENDIX section, pages 12 and 13.

Cash Flow change examples

As the CASH equation demonstrates, adding or subtracting on one side of the equal sign affects the total on the other side of the equal sign. Here is a review of some examples.

1. Increasing Inventory decreases Cash Flow; why? Because buying additional inventory requires cash.

2. An increase in Credit Sales decreases Cash Flow: why? Because it increases Accounts Receivable, which ties up cash until clients pay the company.

3. Increasing Accounts Payable means increasing debt to suppliers, which frees up cash to use for other purposes, and cash Flow Increases.

4. Decreasing Inventory increases Cash Flow because this releases cash previously tied up in inventory.

5. Decreasing Accounts Receivable releases cash owed to the company by clients, therefore increasing Cash Flow.

6. If Accounts Payable increases by $10,000.00 and Inventory increases by $10,000.00, Cash Flow does not change.

7. If Accounts Receivable increase by $20,000.00 and Inventory decreases by $35,000.00, Cash Flow increases by $15,000.00.

8. If Inventory decreases by $15,000.00, Accounts Payable increases by $20,000.00 and Accounts Receivable decrease by $5,000.00, Cash Flow increases by $40,000.00.

I Cash IS King, no cash → no operations → no business.

How can you control your company’s Cash Flow?

The following points are the main items you should focus on:

1. Negotiate longer payment terms and pay your suppliers always on time.

2. Try to shorten payment terms from your clients, only to the point of not compromising your relationship with them.

3. Reduce your Inventory investment using the ABC 80/20 principle and increase material coverage so you can service your customers on time.

4. Always meet your customers’ finished goods demand on time and complete; they will not have any excuse to pay your company on time.

You can manage and control these actions through Supply Chain’s Key Success Factor [KSF] Inventory Management.

The Mastery OPIs - ABC Inventory Analysis for Raw Material - and the - XYZ Inventory Analysis for Finished Goods explain how to use these methods to greatly improve your company’s Cash Flow.

Explore, learn, and understand multiple management methods with our One-Point Insights to achieve superior results.

Read the following related OPIs from Celeran Enterprise Genetics, Inc. at https://celeraneg.com under Management Support Tools → Articles.

You can also download each of the One-Point Insights articles using your email; no need to sign-up, register, or create a password.

1. ABC Inventory Analysis for Materials [Raw and Packaging]

2. XYZ Inventory Analysis for Finished Goods

3. Reducing Supply Chain Risk

4. Measuring Lost Sales and Fill Rates

APPENDIX - Cash flow equation, Basic Algebra.

Refresher: To understand how we arrived at the equation on the fourth row, we should remember the basic algebra rules for rearranging equations.

1. Rule #1

a. You can add, subtract, multiply, and divide by anything if you do the same thing to both sides of the equal sign. Doing the same operation on both sides keeps the meaning of the equation from changing.

Example:

To illustrate how to use Rule #1, we will use a simple equation. We want to isolate g

t = rs + g

To solve the equation for g, we must subtract rs from both sides. (by subtracting rs from rs on the right side, we are removing rs from the right side of the equation and ending up with only g on the right side.)

t-rs = rs-rs + g

Now perform the math on each side: subtract rs from rs on the right; you cannot perform any math on the left, so we end up with this equation:

t-rs = g

We have isolated g, just like we did with CASH on the fourth row in image #3

Typically, the isolated variable is on the left.

g = t-rs

2. Rule #2

a. To move or cancel a quantity or variable on one side of the equation, perform the opposite operation with it on both sides of the equation. If subtracting, then adding; if multiplying, then dividing.

Example:

To illustrate how to use Rule #2, we will use a simple equation. We want to isolate n

n-1=k

To do this, add 1 to both sides: opposite to -1 is +1

n-1+1 = k+1

Now simplify the left side in this example because

-1+1=0 and n-0 = n

and end up with

n=k+1

Once you have practiced, a simpler way of doing this is to move the negative -1 from the left side of the equation to the right side of the equation but now with the opposite operator as positive +1.