Cash flow management: A complex but manageable subject

Posted by  Stéphane Bonutto

In many companies, the processes and tools to manage the profit and loss (P&L) are quite developed, but the cash flow is not always understood and does not always receive the same level of attention. What are the reasons for this and how can FP&A improve the situation?

Why is the definition of cash flow not easy to understand?

In most cases a positive profit result goes hand in hand with a positive cash flow. But some managers do not understand why in selected cases the two numbers can have different outcomes.

A reason for this may be the relatively complex definition of cash flow when compared to the company’s overall result. While the profit is basically revenue minus cost, the cash flow also includes capex, inventory, creditors, debtors and customer or supplier advances. Some of these financial elements may not always be tangible enough for people to understand. On top of this, different terminologies are often discussed such as operating cash flow or free cash flow.

Why is cash flow equally as important as profit?

Firstly, the cash flow is a closer indicator of the company’s ability to remunerate its owners. In small companies, the cash flow position determines how much the owners can withdraw for their personal compensation. In large companies, it represents the value of dividends that can be paid without affecting the cash reserves of the company.

Secondly, the cash flow illustrates whether a company can finance an investment, with or without bank support. For any bank loan, the bank requests an accurate assessment of the client’s cash flow position in order to plan the amounts that can be lent reliably.

How to drive cash flow efficiently?

As a starting point, finance should make all of the cash flow elements transparent and understandable to the entire staff. Then clear responsibilities should be assigned to specific departments who can take effective actions. Since I have already addressed Capex management in a previous blog, here I will concentrate on the drivers of the net working capital (NWC).

In manufacturing companies, inventories are a major element of the NWC, along with their associated raw materials, spare parts, semi-finished and finished products. Depending on the size of the company, inventories will be the responsibility of the production department, or the responsibility will be split between supply chain and production. Target inventory values should be determined in relation to the sales level.

In my opinion, the collection of debts is not the sole responsibility of the finance department. On the contrary, it should involve sales support and the customer facing salesforce. Accounting should take care of the debt chasing and work out the root causes for overdue payments. The sales department should reluctantly follow up on these cases during their customer contact until the payment is resolved. In order to risk of debt write-off, customers credit checks should be carried out ahead of of new orders and on a regular basis.

Amounts payable are largely impacted by discounts and payment terms. The optimisation of these parameters usually involve the purchasing and finance departments. Procurement, or the purchasing department, is typically focused on achieving material cost savings from year to year as well as selecting the optimal supplier for new materials and services. Finance should ensure that the negotiated payment terms are at least in line with industry standards. Any improvement of payment terms from year to year also contributes to the company cash flow position.

How to organise an efficient cash flow report?

Finance should primarily determine a common and stable cash flow report across the company. Ideally, the cash flow statements should be displayed in a clear way. In most cases the cash flow is derived from the profit, capex and net working capital, referred to as the indirect calculation.

In order to receive the same level of attention as the result, the cash flow should be part of all regular planning and reporting processes. Especially in companies who are subject to P&L statement submissions. Key driver analysis should also be performed for the cash flow and the P&L. The position of inventories, debtors and creditors should be measured in relation to sales, e.g. in terms of days.

Finally, similar to the P&L, the cash flow position should be budgeted and forecasted. For this purpose, clear objectives and rewards should be assigned to operational leader across production, logistics, sales and purchasing. As with cost drivers, this assignment of responsibility should ensure that the cash flow drivers receive adequate focus during the year.

Stéphane Bonutto

Stéphane Bonutto has worked in various multinational companies such as Schott Glas and Adam Opel AG in Germany, Switzerland and Italy where he was responsible for commercial finance / pricing and manufacturing finance. He then moved to Oerlikon Balzers to work as Head of Finance / CFO for Germany and then for Europe. 

During his career, Stéphane designed and implemented Finance Planning & Analysis tools to drive the performance of the organizations. He also has worked on processes and organizational capability to bring his finance teams to the next level.