Download Cash Flow Mismanagement May Deteriorate SME’s Financial Status

Cash Flow Mismanagement May Deteriorate SME’s Financial Status
，
Han Peng Tang Jiahai
Shandong University of technology, P.R.China, 255049
Abstract: Owing to the imperfection of the social credit system, insufficient cash flow could easily
cause the recessive financial crisis of SMEs to continue to deteriorate. This paper explores preventing
financial crisis and extending the life cycle of SMEs through enhancing the cash flow forecasting,
budgeting and early warning, identifying and measuring recessive financial crisis. Finally, paper mainly
approaches that SMEs should create advanced cash flow technology platform to prevent recessive
financial crisis worsening.
Keywords: SMEs; Cash Flow Management; Recessive Financial Crisis
1Introduction
The idea that “Cash is king” has penetrated into the enterprise management in the western
developed country. But SMEs in China lacks sufficient capital accumulation, venture capital and the
relative scarcity of operating capital. Financial objectives of SMEs are set for the maximization of profit,
so short-term behavior is serious. Based on China Securities Journal of 2004, SMEs board in China was
formally established in May 2004, among which, cash flow per share of 13 SMEs was negative. Three
SMEs have little money on their cash flow per share. There are 10 SMEs whose cash flow statement has
been vacant for two years, so the development prospect is worrying.
The research on Science Investment shows that the average survival period of SMEs in China is
only 2.9 years. Almost 1,000,000 SMEs are closed every year. The life cycle of 80% of SMEs does not
exceed five years. [1] There has been little research on "Short-life Phenomenon" of the SMEs from the
①
perspective of the recessive financial crisis . Lack of cash flow triggering the process of financial crisis
is asynchronous. If SMEs do not improve the forecasting, budgeting and early warning of cash flow and
are unable to correctly measure the extent of the financial crisis, financial crisis of SMEs will be
worsening. As a result, SMEs can not avoid the doomed fate, that is, as Mr. Cairns said, "Finally, we will
die."
The dead has died and it should become a warning to later SMEs. The SMEs have gone bankrupt
owing to the continuing shortage of cash flow. Mutual debts arrears In 1980s and 1990s have resulted in
the breakdown of state-owned enterprises. SMEs should learn the lessons. What should be emphasized
is that because the social credit is deficient, financing channels are sluggish; there is profit on the books,
but no cash in most of SMEs.
In order to narrow the gap with the developed nations, to extend the life cycle and to adapt to the
changes of market economy, the current situation and theory call that SMEs should strengthen cash flow
management and timely identification and measurement of the recessive financial crisis to prevent the
financial crisis.
2Recessive financial crisis and cash flow management
2.1 Cash Flow inadequacy is a key factor to recessive financial crisis
The capital of SMEs is so weak that SMEs are difficult to survive. Many of their financial goals are
① Recessive financial crisis is usually defined as customer dissatisfaction resulted from recessive
liabilities that the enterprises did not pay off. As a result, customer dissatisfaction leads to noncooperation of enterprises. Recessive liabilities are the differences between enterprises fulfilling the
commitment and customer expectations. SMEs pay little attention to cash flow management and do not
identify the impact of cash shortage on the turnover of capital and the operation of enterprises. So we
name “recessive”. If enterprise focuses on cash flow management, the financial crisis resulted from
continuing deficiency of cash flow can not be referred to as recessive financial crisis.
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mostly profit maximization. In order to open up business market to complete the task of departments
and individuals, SMEs focus on sales growth, which results in more serious credit sale and an increase
in receivables. Because our accounting system for the revenue and profit recognition system use the
accrual rather than a cash receipt, it results in the differences in the amount of SMEs income, profits and
cash and also causes the increase of profits on the book, but no real cash. If the SMEs regarding profit as
first do not enhance cash flow management, recessive financial crisis will occur. Moreover, in order to
save cost, the deficiency of cost of the design and quality will cause the recessive liabilities of products
or services to increase, such as maintenance cost, claims, lawsuits, etc., and other receivables cycle will
be extended. As a result, the cash shortage will become more serious and the recessive financial crisis
will appear consistently. And the mutual arrears in lending, accounts payable, taxes, wages of poor credit
lead to the financing difficulties of SMEs. Thus, the purchase of raw materials can not be done promptly.
Moreover, the inflow and outflow of cash are often asynchronous, which results in non-timely salaries
and non-cash payment of taxes. Thus, workers quit their jobs; the government fines and in the end the
enterprises have to cease the production and consequently, serious financial crisis happens. It can be
seen from this that ignoring cash flow management in SMEs is an important factor causing recessive
financial crises. Cash is the most liquid of assets and it represents the lifeblood for growth and
investment. In order to generate cash, SMEs must efficiently and effectively manage the activities that
provide cash. Cash flow refers to the flows of cash, literally, into and out of the business. Think in terms
of actual cash, bills, flowing in and out of SMEs, and then identify both their sources and uses to
identify cash flow fluctuations over an annual period. Indeed, profits are a critically important indicator
of success, SMEs are in business to make a profit at what they do. However, SMEs should know that
there is something even more fundamental to the success of their businesses: cash. If the cash inflows
exceed the cash outflows, SMEs can continue operations. If the cash outflows exceed the inflows, SMEs
runs out of cash and grinds to a halt. Even if the imbalance is only for a short period, it can spell disaster.
Cash management, controlling the cash flow, is vital to businesses of all sizes. SMEs are especially
vulnerable to cash flow problems since they tend to operate with inadequate cash reserves or none at all,
and worse, tend to miss the implications of a negative cash flow until it's too late.
2.2 Effective recessive financial crisis management tool: forecast, budget, early warning
2.2.1cash flow forecast
From a strategic viewpoint, cash flow forecasts are an effective recessive financial crisis
management tool for SMEs[1]. The forecast will provide relevant information to SMEs executives to
assist in proactive management to enhance SMEs performance. Management can re-plan and re-allocate
resources across the SMEs units to meet SMEs targets and regularly review the performance of each
SMEs unit in accordance with these targets. Furthermore, the cash flow forecast will provide
information to the SMEs that will assist in developing key messages to manage expectations of external
stakeholders. Forecasting is always a challenge. The key to monitoring and managing these cash flows is
to ensure that there is always a reasonable buffer between what flows in and what must flow out. It is the
uncertainty of events that engenders that challenge, and is often the deterrent in even attempting to
forecast with any accuracy. A forecast is based on actual events, without intervention, and should have
real cash movements factored into the process. The process for forecasting cash flows will involve a
number of factors that can include dedicated resource, integration of SMEs units, possible technology
upgrade, and, more often than not, culture change. Indeed, accurate cash flow forecasting can become a
key tool to support the operational and strategic objectives of any SMEs. When undertaken in a
disciplinary manner, cash flow forecasts will increase profitability, provide information to support
acquisition opportunities, and even improve customer relations. The cash flow forecast can become an
operational driver of the SMEs and can assist in performance measurement.
Properly designed cash flow forecasts do provide real benefits. These often fall into three
categories: financial, operational and strategic. Most that work within the finance industry will easily
identify the financial benefits, which include reduced reliance on external funding, more efficient
transaction processing, improved credit rating, less sensitivity to interest rate movements and
optimization of corporate financing. Most importantly, a cash flow forecast will provide early warning
signs to recessive cash flow crisis. If a company has some certainty around SMEs cash flows they will
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be able to plan production runs with confidence, hence reducing income volatility. Through analysis of
the cash flow forecast, factory efficiencies can be improved and inventory levels reduced. Ultimately,
this will lead to enhance competitive profile.
2.2.2 cash flow budget
Some SMES believe that the annual budget is a sufficient forecast. However, it is important to draw
a distinction between budgeting and forecasting. A budget is set annually on the basis of where a
company would like to be, and is set with the planned events, activities and interventions required to
achieve those targets.
A cash flow budget is arrived at through a projection of future cash receipt and cash disbursements
of the SMEs over various intervals of time. It reveals the timing and amount of expected cash inflows
and outflows over the period studied. With this information, the manager is better able to determine the
future cash needs of the SMEs, plan for the financing of these needs, and exercise control over the cash
and liquidity of the SMEs. While cash budgets may be prepared for almost any interval of time, monthly
projections for a year are most common. This enables analysis of seasonal variations in cash flows.
When cash flows are volatile, however, weekly projections may be necessary.
[2]
A good cash budget identifies both short-term and long-term debt sources . For short-term needs,
your cash budget might indicate that your bank is the best alternative to borrow funds, or you might be
able to establish trade credit with your suppliers. The value of a cash budget is that you don't need to
scramble when the expected or unexpected strikes.
2.2.3cash flow early warning
One important element in cash flow management is to fully understand the warning signs of recessive
financial crisis. Some signs include:
Cash balances are low compared to historical balances.
(1)Inventory is not moving.
(2)Vendor payments are made late.
(3)Banks are requesting financial statements.
(4)Major purchases have to be postponed.
(5)Management has become very risk adverse; i.e. overly cautious about spending money.
One way to monitor cash flow is to track liquidity ratios and compare these ratios to historical ratios and/or
industry averages. Some examples include:
Current Ratio = Current Assets / Current Liabilities
Acid Test = Cash + Accounts Receivable + Marketable Securities / Current Liabilities
Cash Flow to Debt Ratio = Cash Flow / Total Debt
Cash Flow to Income Ratio = Operating Cash Flow / Net Income
Another warning sign is an unfavorable Z Score. The Z Score is about 90% accurate in predicting bankruptcy
in the first year and about 80% accurate the second year. The Z Score combines five ratios and compares the
result to a scoring scale. A weight is assigned to each ratio. The Z Score is calculated as follows:
Z = 1.2 (A) + 1.4 (B) + 3.3 (C) + .6 (D) + .999 (E)
A: working capital / total assets
B: retained earnings / total assets
C: earnings before interest taxes / total assets
D: market value of equities / book value of debt
E: sales / total assets
The scoring scale for the Z Score is:
If the Z Score is 1.8 or less, there is a very high recessive financial crisis
If the Z Score is 1.81 to 2.99, we are not sure about recessive financial crisis
If the Z Score is 3.0 or higher, recessive financial crisis is unlikely.
3 Create advanced cash flow technology platform to prevent recessive financial
crisis worsening
Accurate and timely information is the key to better management. It’s clearly the latest
technologies that are driving the delivery of that information [3]. Technology is now converging to
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provide that information, the technology between the bank systems, the ERPs, the treasury systems and
the global Internet capability. Ultimately, technology will give SMEs the ability to forecast, budget,
and early warning cash flow to prevent recessive financial crisis worsening.
The greatest advancement in recent times has been, and will continue to be, the advance of the
Internet and Web-based activity [4]. It is not being Web-based that actually adds value, but rather the
speed, security and ubiquity of information that is actually driving the sources of value. In west,
Mass-market personal Internet banking has been a reality for several years. The value of the Internet to
banking has not just been in balances and transactions on a personal level, but rather as consumers we
now have the capability to have real-time quotes, up-to-date information and comparative data presented
instantly for us to make better decisions. Treasury systems have been evolving to add real-time data
feeds for many years now. The advantages in technology are now evolving such that enhancing and
changing predicted cash-flow incomes is now imminently possible, and they can be achieved right
across the financial supply chain. It is now clear that technology is emerging to ensure that treasurers
have more power to control cash, rather than cash being an outcome.
Technology has been enabled and designed to ensure that no person working in cash management
will actually need to do any transactions in the future. For some, that’s a very controversial statement.
The combination of ERP systems, treasury systems and banking solutions means that this will ensure
that is the case. The time currently spent in actually processing transactions will be completely
eliminated, in our view. The control methods will be rules-based and outcome-oriented. Paying suppliers
earlier for trade discounts will be an automated rule based on financial reward, risk, minimum balance,
financing costs and other parameters. The time previously spent looking at transactions will be spent
modeling what-if trade-offs, because the transactions will occur automatically and they will achieve the
best outcomes against the treasurer’s rules that have been put into place. Clearly, the actual pay-away
will still need to be authorized as a control procedure, but with the advent of third-level authentication
such as personal tokens in addition to passwords, these authorizations will be safer than ever.
Automation will not mean a loss of control. Technology in cash management will ensure that SMEs will
be able to set these rules and authorizations on accounts in real-time from anywhere at any time. As a
consequence of this technology, enablers will also predict a further centralization of treasury functions,
and that will mean there will be fewer locations of treasury activity.
Cash management technology will need to pick up all purchase orders at the time that they’re sent,
and feed this data into cash-flow forecasts [5]. Similarly, all invoices will have agreed dates for automatic
payment, and increasingly, we predict, agreed dates for terms of trade as part of the supplier agreements.
Supplier will code items such as a 2 percent discount for payment in seven days, and the system will
automatically decide whether to make those payments early or not. This flexibility in cash management
will be contrasted with the need for all likely and potential transactions to be included in treasury
systems as early as possible. As such, procurement officers will need not only to include amounts of
currencies and volumes and payment amounts in their input, but they will also need to conform to the
rules in terms of trade that have already been agreed in the systems. This means the flexibility of buying
today, right now, for settlement tomorrow, may need to be compromised in many organizations, or they
will need to be catered for in the systems.
4Conclusion
This paper has come to the following conclusions: first, SMEs overlook cash flow management and thus
unable to use the means of forecasting, budgeting, pre-warning to identify and measure the recessive financial
crisis. This is an important element in deterioration of financial crisis. Secondly, with the advent of IT
technological revolution, SMEs should seize the opportunity and use the platform of advanced technology to
achieve real-time and accurate cash flow management. Finally, from the current situation of China's SMEs and
the point of view of sustained development, it is unrealistic if we simply rely on advanced technology to
enhance cash flow management to prevent financial crises. Authorities of SMEs should foster the idea of
“Cash is king” and focus on the cash flow management.
References
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