Managing Cash Flow Presented by Kate Barr, Nonprofits Assistance Fund

Session objectives Strategies for managing cash flow The importance of proactive cash flow management Cash flow projections Understanding working capital Analyzing working capital needs Learn from your peers

Part I Cash Flow Projections

The importance of monitoring cash flow Cash flow is the fuel that sustains organizations and programs Cash flow shortfalls are disruptive Cash flow shortfalls are costly

Monitoring cash flow Recognize the difference between negative cash flow and deficits Essential principles of managing cash flow: Project and anticipate Prepare options and strategies Respond and adjust to changes

Projecting cash flow When to prepare cash flow projections Cash flow management philosophy Base line cash balances Use of credit lines Use of restricted grant funds Projecting uncertain income

Projecting cash flow Start with reliable budget information Understand contract and grant terms and experience Understand operating cycles – payroll, contracts Include cash required for capital purchases and debt service

Preparing projections Level of detail by line item Time periods for projections Use of projections – management, board, outside users Provide training for users of the projections Frequency and level of updates

Projecting cash receipts Grant income – committed & uncertain Restricted and special project funds Receivables collection Contract receivables Individual fundraising Pass-through funds

Projecting cash disbursements Reflect the anticipated timing of payments – not always divided by 12 Payroll and benefits payment schedules Seasonal activities Contracts and agreements with lump sum payments Debt service and capital purchases

Using cash flow projections What is a cash flow problem? Anticipate cash flow shortfalls Advance planning = more options Clarify roles and responsibilities for addressing projected shortfalls

Strategies for cash shortfalls Access operating cash reserves or available credit line Have a plan for repayment Speed up cash receipts Slow down cash disbursements

Part II Defining and Analyzing Working Capital

Defining working capital Working capital is always the first use of cash Businesses and nonprofits fight a three-front war over the use of their cash: Fixed assets Debt service Working capital Working capital is the first use of cash because a business or nonprofit cannot operate without inventory or service providers

Defining working capital Seasonal working capital Temporary financing needs tied to the business cycle or specific contracts Financing rests during off season Permanent working capital Longer-term investment to finance steady growth over a period of time Depends on proven pattern of sales or revenue growth

Defining permanent working capital (PWC) Permanent investment of cash into operating assets and liabilities required to support revenues Accounts receivable Inventory Accounts payable Accruals

PWC formula Accounts Receivable +Inventory -Accounts Payable -Accruals =Permanent Working Capital

Measuring PWC Amount of PWC is determined by three factors: Operating cycle(s) Revenue levels Rate and/or timing of revenue growth

PWC and the operating cycle Length of time, measured in days, that cash remains in operations before turning back into cash Known as the cash-to-cash cycle Determined by: Industry norms Management capacity Economic and market conditions Policy considerations

Theoretical operating cycle Receivable terms +Inventory cycle -Supplier terms -Payroll cycle =Theoretical Operating Cycle

Actual operating cycle Days receivable +Days inventory -Days payable -Days accrual =Actual Operating Cycle

Variations in operating cycles Community Health Center Nonprofit organization Days accounts receivable Days grants receivable -Days payable -Days accrual =Operating Cycle

Types of business operating cycles Long Health Center Short Childcare Negative Restaurant Days receivable Days inventory2003 -Days payable Days accrual14 7 =Operating cycle9625(34)

Comparing PWC needs: Revenue of $1 million Health Center ChildcareRestaurant A/R$325,000$123,000$ 0 +Inventory 5, ,000 -A/P 25,000 18,000 58,000 -Accruals 30,000 27,000 = PWC Needs $275,000$ 75,000$(79,000)

Rule 1 of PWC analysis The longer the operating cycle, the more difficult it is to grow. While the health center must invest 96 days, or $ 275,000 to support revenue, the childcare center invests only 25 days of cash, or $75,000. The restaurant do not invest any cash in operations—they use other people’s money.

Rule 2 of PWC analysis Financing one day of Accounts Receivable takes more cash than one day of inventory. Receivables include the full value of all costs and require more cash to support than other assets.

PWC and revenue level Businesses and nonprofits with positive operating cycles need more PWC for every increase in revenue If the Health Center’s revenue doubled to $2 million, and the operating cycle stayed the same, PWC needs would increase to $550,000. Impact of revenue growth can be moderated by improved control of the operating cycle—as long as it improves for the right reasons (i.e., faster collections not slower payments).

PWC and rate of growth Businesses and nonprofits experiencing rapid growth syndrome face most serious problems financing PWC (if have a positive operating cycle) Need for PWC grows faster than a company or nonprofit can convert profits or surplus into cash. Sometimes gap can be filled only by equity or grants to lower the financial risk inherent in rapid growth.

Planning Working Capital Needs A step beyond managing cash flow Plan the operations and policies for all working capital components Analyze the costs and opportunities of different working capital scenarios

Step 1: Calculate existing PWC on the balance sheet. Accounts receivable +Inventory -Accounts payable -Accruals =PWC All nonprofits except startups have an existing investment of PWC quantified on their balance sheet. New PWC is the difference between existing and projected PWC needs.

Step 2: Determine key assumptions for PWC projections. Use most recent trends. Determine six assumptions. Rate of revenue growth Direct Costs/Revenues Days receivable Days inventory Days payable Days accrual

Example : Change Receivables Cycle CurrentLongerShorter Days receivable Days inventory20 -Days payable Days accrual14 =Operating cycle

Example : Change Receivables Cycle Current cycle LongerShorter A/R$325,000$487,000$271,000 +Inventory 5,000 -A/P 25,000 50,000 25,000 -Accruals 30,000 = PWC Needs $275,000$ 412,000$221,000

Step 3: Project growth by using reverse operating cycle equations Days rec/360X projected revenue = Accts. Receivable Days inv/360X projected COGS = Inventory Days pay/360X projected COGS = Accts. Payable Days acc/360X projected COGS = Accruals New PWC

Step 4: Subtract existing PWC from projected PWC needs. $New PWC Needs - Existing PWC Investment = $PWC to be funded or financed

Managing working capital Understand the operating cycle Identify the controllable factors Manage all factors in the cycle Calculate the costs of working capital Strategically invest in shortening the operating cycle Communicate with management and board leaders