An important role of the finance manager is securing proper financing for the company so that there is always a proper amount of cash available for short- and long-term requirements—making payroll, paying creditors, taxes, and overhead expenses, and buying new equipment. After all, bankruptcy is not a problem from the balance sheet of total assets and total liabilities, nor is it a problem from the operating statement of revenue and net income. It is strictly due to an untenable shortage of cash.
What exactly do I mean by those last 2 sentences?
Bankruptcy is all about a business not having enough cash to run its operations, the balance sheet or even income statements are not culpable in the business going bankrupt, they are simply documents which do not determine how much cash a business has to fund its operations, this is purely a financial decision and the buck stops with the person in charge of finance in the business. It is his/ her job to ensure the company has enough cash for both short- and long-term requirements. The books of account may look fine but a small unexpected event occurs and the company has to declare bankruptcy simply because proper financial planning was not done.
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What are some factors that must be taken into account by the finance manager when determining how much cash needs to be on hand at all times, and over a longer period of time?
A number of factors need to be taken into account when determining current and future cash projections such as accounts receivables, payables, credit terms e.t.c. Accounts receivables are the funds the company expects to receive from sales to its customers and will have a positive effect on its cash position. Payables are the accounts the company expects to fall due and will have a negative effect on the company’s financial position. Credit terms refer to the time limits given to customers to pay their debts and will determine the inflows of cash into the business both in the short and long term but more especially in the long term. A mix of these factors will help the manager know how much cash the company is expecting to receive at various times, and how much needs to be paid out and as a result how much should be in the company at any given time.
What types and sources of financing does the smart finance manager use to balancing these various types of needs and horizons of time, while also mitigating the risk of having access to cash in the future?
For the smart finance manager, there are three main sources of financing that can be used to balance the needs of a business over time; Internally generated funds, debt financing and equity financing. Internally generated funds can take care of the daily expenses involved in running the business such as utility bills, rent, and so on. Debt financing involves acquisition of loans and is good for the mid-term to long term needs while equity financing can be used for huge long-term projects or ventures that the company plans to get into.
How does that manager know that the right balance of those types of funding is in place?
For a manager, the right balance of these funding types is when he/ she can imagine all sorts of scenarios/ business ventures the company can find itself in and the company is in a position to take care of these situations through these funding types.
After making the decision on how much cash is necessary today and, in the future, what financial ratios would you monitor to be sure that your plan was working?
Various financial ratios need to be monitored to ensure the company’s cashflow plans are in a positive position. Cash flow coverage ratio, which is operating cash inflows divided by total debt, is used to determine the company’s ability to pay up on its debt. The cash flow margin ratio shows the amount of cash that is generated per dollar of sales by the company. Other ratios include current liability coverage ratio, price to cash flow ratio, and the cash flow to net income ratio.
