Launching a successful business requires the creation of a solid financial plan to raise the capital needed for the business to be profitable which requires sound financial planning. To accomplish this, entrepreneurs rely on three financial statements namely, the balance sheet, the income statement and the statement of cash flows.
According to Scarborough and Cornwall, “cash management involves forecasting, collecting, disbursing, investing, and planning for the cash a company needs to operate smoothly. For a start-up business, managing cash depends on the accuracy of the financial forecasts that come from a well developed business model and business plan.”
There are five (5) steps in creating a cash budget, namely:
1) Determining an adequate minimum cash balance. This should be determined based on past experience and seasonal fluctuations should be considered.
2) Forecasting sales. This is the heart of the cash budget since sales are transformed into cash receipts and disbursements.
3) Forecasting cash receipts. Sales constitute the major source of cash receipts. It should account for delays in payment for goods or services sold on credit.
4) Forecasting cash disbursements. The key factor here is to record them in the month in which they will be paid, and not when the debt or obligation is incurred.
5) Estimating the end-of-month cash balance. Entrepreneurs first must determine the cash balance at the beginning of each month which includes cash on hand and cash in checking and savings accounts. (Scarborough & Cornwall, 2015)
The fundamental principles involved in managing the “Big Three” of cash management are as follows:
a) Accounts receivable. Controlling accounts receivable requires business owners to establish clear, firm credit and collection policies, and to screen customers before granting them credit. Sending invoices promptly and acting on past due accounts quickly also improve cash flow. The goal is to collect cash from receivables as quickly as possible. A recent personal experience is a small lingerie business I work at on a part-time basis. I was recently extended credit on several items sold at the store. While I am a responsible person, I think it is very risky to extend credit to anyone as you may end up with “deadbeat” customers. However, a lot of the customers are cancer survivors and most of their expenses are covered by their respective insurance companies.
b) Accounts payable. When managing accounts payable, an entrepreneur’s goal is time payables to coincide with cash being collected from customers. Techniques to better manage payables include verifying invoices before paying them, taking advantage of cash discounts, and negotiating the best possible credit terms. Setting payment calendars, keeping paperwork organized and being consistent with payments to creditors is important. Most of the orders made by the lingerie boutique are paid at the time of order, with the exception of the insurance orders which are paid upon the acceptance by the customer and the proper processing of medical records which can take up to 3 months, depending on the case.
c) Inventory. Excess inventory earns a zero rate of return and ties up a company’s cash unnecessarily. Owners must watch for stale merchandise as inventory frequently causes cash headaches for small business owners. The lingerie boutique has quite an inventory but most items seem to move fast. Those that don’t usually are discounted or paired with a deal like a BOGO. Otherwise, they are recorded as a loss.
A decent balance of cash management coupled with a strict and timely handling of accounts receivable, payable and inventory are crucial to a small business success.
The financial plan is important for small businesses because it helps the owner develop a clear vision of where the business stands and where it is heading for the future. It is “a blueprint for continual improvement in the company performance” (Hill, n.d.). By incorporating cash management skills, having long-range views, spotting trends, prioritizing expenditures, and measuring progress, the small business owner can create a “forward focused” business plan and can see where their success lies and where the business may be lacking and can help guide the business owner for future success (Hill, n.d.).
The 5 steps to creating a cash budget include:
1. Determining a sufficient minimum cash balance: The best method for deciding on an acceptable cash budget is to use past experience as references.
2. Forecasting sales: This is the main source of cash flow into a business and is the focal point in a cash budget.
3. Forecasting cash receipts: The cash budget must account for the time between sales on credit and when that cash is actually collected for the sale.
4. Forecasting cash disbursements: Make sure to record cash disbursements in the month in the month they are paid, not when the debt was incurred.
5. Estimating the end-of-month cash balance: To estimate end-of-month cash balance, determine cash balance at beginning of month, add projected total cash receipts and then subtract projected total cash payments to get the end-of-month balance (Scarborough & Cornwall, 2015).
The “Big Three” of cash management involve:
1. Accounts Receivables: Owners need to establish clear and assertive credit and collection policy by screening customers carefully before giving credit, writing out the credit policy and informing customers of terms in advance, sending invoices promptly, and taking immediate action when an account first becomes past due.
2. Accounts Payables: Pay promptly so owners will develop good relationships with suppliers. In turn, suppliers will provide good service to the business, be more understanding and willing to work with you if you find yourself in a financially difficult situation. Paying creditors promptly will help your business maintain good credit ratings which will be useful in the future. Ideally, you should regulate payments to vendors and suppliers to coincide with collection of accounts receivables.
3. Inventory: Owners must keep an eye on their inventory levels. Businesses do not earn any return on investment for inventory that sits on the shelves and holds up the businesses cash (Scarborough & Cornwall, 2015).
According to Evans (2016), the overbooking model is a common practice used by service businesses to decide how many reservations to accept in order to fill capacity knowing that some reservations will go unused resulting in lost revenue opportunities. To combat and reduce this possibility, businesses will overbook to compensate for cancellations and no-shows. If more customers were to arrive than can be accommodated, there is usually some overbooking cost incurred that must be balanced with the lost revenue for underuse. Thus, effective overbooking requires a crucial decision of how much to overbook by and a plan for any overcapacity.
When I worked at a dental clinic on base, we used an informal variation of the overbooking model (without even realizing it) when a hygienist would call out sick. At the time, we only had three hygienists for a population of about 5,000 active duty members, so our hygiene appointments were often booked out months in advance. And since many service members would often leave for deployment or training on short notice, we tended to have no-shows like any other service business. Therefore, on a day when a hygienist called out sick, instead of calling all of their scheduled patients to reschedule, we just moved their appointment over to one of the other two hygienists-overbooking the schedule. If one patient did not show up at their scheduled time (which was often the case), then the patient that was moved over would still be seen even though their provider was not there that day. If all three patients showed up, we would have a prophy tech do the cleaning. In this case, overbooking worked for us because we were able to effectively fill capacity and balance the costs of overbooking against lost revenue and wasted manpower for underuse.
Monte Carlo simulation is generating random values for uncertain inputs in a model, computing the output variables of interest, and repeating this process for many trials to understand the distribution of the output results. Hypercube simulation is known as Latin Hypercube simulation because us is an overview on the Latin square. Hypercube simulation is a way to generate random samples by dividing data equally and choosing random outcomes. Monte Carlo simulation represents real world outcomes. The Monte Carlo Simulation can be found more in financial risk management. While both Monte Carlo and Hypercube simulations are both common sampling methods, Hypercube simulation improves efficiency.
Hypercube sampling is used during in Monte Carlo Sampling to reduce the number of runs used to get an accurate result. An example of hypercube would be gathering and comparing data. An example of Monte Carlo simulation is like rolling die and figuring out the correct combinations of rolls.