5 Reasons for Cash Flow Management and Planning (2024)

By Amrish Shah, CFO at Metabolic

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In this blog, we will look at some key reasons why good cash flow planning and management is key to a healthy and sustainable future for any business. In particular, we will look at how can play a stronger role than they have played historically.

"Profit Is Vanity, Cash Is Sanity"

In other words, running out of cash from operations or reserves means an inability to pay suppliers for goods and services required to keep the business running. Whilst profits can be accounted for in many ways, some more creative than others, it is impossible to misinterpret what is held at the bank or in cold, hard cash. It is true that when cash runs out, a business can continue to exist purely on credit or other forms of lending, such as shareholder equity injections or loans. These inflows are not sustainable because they will stop when the risk of default (non-payment) becomes unacceptable to the lender or when the risk of losing capital investment becomes too high for equity owners.

An organisation cannot use profit to trade; it uses cash. Therefore, cash needs to be properly managed and planned for like any other asset. There are several reasons why organisations have to pay close attention to their cash flow management practices. Yet the ultimate consequence of neglecting them is a business failure and, in its most extreme form, a business ceasing to exist.

Optimising cash utilisation

Too much cash can be a problem, especially when the interest rate is negative, very low or very high. It signals that the organisation is not able to find any productive use for its cash to help improve future performance. Without visibility and insight into cash flow trends, it is impossible to optimise this situation. Ultimately, this situation will not be allowed to persist since business owners will start to demand larger cash disbursem*nts such as increased dividends, share buyback or debt repayments. By being involved in the corporate financial strategy process, FP&A can provide valuable support.

Funding short-term operations

Not having enough cash can lead to short-term liquidity issues. In this case, organisations might lose their reputation and damage relationships with suppliers and employees. For example, an inability to meet payroll commitments will not satisfy staff. Normally, these risks would be managed by the treasury function, which leads the short-term cash flow forecast process. FP&A can proactively work with the business and treasury to be aware of action options that can be taken to avoid material liquidity issues. For example, the solution could be to offer additional incentives to suppliers to accelerate the rate of incoming cash.

Meeting medium-term investment requirements

This is important in order to support the agreed business objectives. The main risk here is an organisation missing opportunities to meet future performance expectations. If mismanaged, capital projects may be delayed and, in extreme cases, stopped. FP&A should ensure that a robust capital investment process is in place and that there is a strong link between expenditure timings and the forecast process.

Avoiding the need for emergency cash

Emergency cash is likely to harm an organisation's reputation, lead to higher costs through interest payments and give financially secure competitors an opportunity to mount tactical attacks. FP&A can work with internal and external business stakeholders to ensure a clear communication strategy. It is especially important for key customers and suppliers at risk of competitive attack.

Avoid breaching covenants

Many organisations, especially private or small to medium-sized ones, have agreements with external funding institutes that require minimum cash flow levels. Breaching these can lead to severe penalties, including, at the more extreme end, taking control of assets or forcing the sale of assets at a distressed price. For public companies, such insolvency can impact creditworthiness and make future finance raising costlier. FP&A need to ensure that the management team have complete visibility of this risk as early as possible, along with associated contingency planning. This will allow the CFO to present contingency plans to lenders proactively so they can explore constructive action options promptly together.

Summary: Cash Flow Is the Lifeblood of an Organisation

Without sustained positive cash flow development, an organisation will be at risk of becoming insolvent. In order to avoid this, as well as any shorter-term liquidity issues, cash flow needs to be managed and planned for with as much attention as the P&L. Harnessing and leveraging modern technology and especially adaptive and flexible planning and forecasting tools will help FP&A improve the organisation's cash flow planning and management and thus help the organisation to navigate an ever-changing business environment better.

This article was first published on the Unit4/Prevero blog.