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Money Management

By Richard E. Crandall, PhD, CFPIM, CIRM, CSCP | May/June 2011 | 21 | 3

Why your operations people should take the lead with cash flow

Who is responsible for cash management at your business? If you surveyed a group of managers, there’s a good chance many would say the finance or accounting professionals are in charge, depending on how the company is organized. But that perspective is much too limited. It’s operations managers who should be in the middle of cash flow discussions and decisions.

First, let’s expand the subject from cash management to cash flow management. Here, “flow” implies inflow and outflow. Cash is generated through the operations of a business; accounting and finance workers take care of the disposition or application of cash. Today, there are three primary financial statements: income statement, balance sheet, and cash flow statement. This hasn’t always been the case. For a long time, most businesses operated on a cash basis, so financial statements essentially were cash basis financial statements. Once accrual accounting became popular, the preferred financial statements became the balance sheet and the income statement.

However, there were occasional glimpses into the need for cash flow reporting. Thompson and Buttross (1988) provide the following sequence of progression:
  • 1863: The Northern Central Railroad issued a summary of financial transactions that reconciled the beginning cash balance and receipts to the disbursements and ending cash balance.
  • 1893: The Missouri Pacific Railway Company issued a statement showing resources and their application during the year.
  • 1902: The United States Steel Corporation included a report that used current assets minus accounts payable as the definition of “funds.”
  • 1963: The American Institute of Certified Public Accountants supported the preparation of a funds statement showing the source and application of funds.
  • 1971: Accounting Principles Board (APB) number 19 modified APB number 3, but the definition of funds was ambiguous and the suggested title, “Statement of Changes in Financial Position,” uninformative.
  • 1978: Statement of Financial Accounting Concepts (SFAC) number 1 provided renewed emphasis on cash flows and was further supported in SFAC number 5.
  • 1988: Statement of Financial Accounting Standards (SFAS) number 95 required a statement of cash flows when a “complete set of financial statements is issued.”

Wampler, Smolinski, and Vines (2009) argue that further modifications are needed in SFAS number 95, particularly in the direct method of presenting cash flows.

After a long and heavily debated journey, cash flow statements now are an integral component of financial reporting, at least in public companies.

There still is considerable debate among scholars and public accountants about direct and indirect methods of presentation. However, most companies use the indirect method of presentation, which nicely connects the income statement with the balance sheet. (For a more detailed explanation of these connections, see Crandall 2002.)

Most cash flow statements have these major categories:
  • Operating activities involve net income before depreciation and other non-cash items, plus working capital changes.
  • Investing activities incorporate sale and purchase of investments, acquisitions, and capital expenditures.
  • Financing activities encompass the incurrence and payment of debts, stock issuance or purchase, and dividends.

The central theme is that the marketing and operations functions are charged with the responsibility of generating cash from their activities, while the accounting and finance functions have the responsibility of using that cash for the benefit of the company and shareholders.

Cash generation
The generation of any significant amount of cash by operations requires marketing and operations to work together to produce revenues and operations to manage the expenses in order to produce an acceptable income. It also necessitates the operations functions to manage the working capital in order to avoid accumulating assets that consume cash in the short term and may not be salable if held too long.

Inventory and capital equipment can be thought of as stored expenses. Eventually those costs will be included as expenses in the income statement. Table 1 shows brief statements of the actions needed by operations managers to assure acceptable cash generation.

If the company has good products and strategies for exploiting those products, good operations managers usually can generate sufficient cash to keep the organization competitive. Most readers will relate to the difficulty of this responsibility.

Cash applications
Once cash has been generated, it is the responsibility of finance and accounting professionals to properly manage that resource. Of course, every company will have different uses for that cash. Marketwatch.com offers some real-world examples from Cisco, Intel, Apple, and Procter & Gamble.

Over a three-year period, Cisco generated $30.7 billion cash after capital expenditures. The company used $16.7 billion to purchase short-term, or near-cash, investments; $6.1 billion for acquisitions; and $7.3 billion to repurchase stock. The net increase in cash over this three-year period was about 3 percent of the total generated. The business did not pay a stock dividend. Its depreciation expense was 169 percent of its capital investments, which may suggest it was delaying capital expenditures or increasing outsourcing commitments as a means of reducing capital investment.

During the same three-year period, Intel generated $21.0 billion cash. It used $8.2 billion to purchase investments, $7.2 to repurchase stock, and $8.8 billion for dividend payments—about 48 percent of net income. Its cash balance decreased about 12 percent of the cash from operations. The depreciation expense was 93 percent of the capital expenditures, which indicates Intel continued to invest in in-house resources.

Apple produced $31.7 billion, also over three years. It is interesting to note the amount generated in 2010 was about equal to the sum of the two previous years. The company used a net of $32 billion to purchase investments and increased cash by $1.7 billion from stock issuance. Its cash balance rose by about 6 percent of the cash from operations. However, the cash balance of $11.3 billion was more than that of Cisco, Intel, and Procter & Gamble combined—the result of Apple’s rapid growth during these years. Its depreciation expense was about 49 percent of capital expenditures, which suggests Apple is investing at a faster rate, probably to keep up with rapid introduction of new products and subsequent success.

Again, over that three-year period, Procter & Gamble generated $39 billion, more than any of the other three companies. The company did little in the investing area, with $1.2 billion expended for acquisitions. The organization paid down debt by $8.6 billion, repurchased stock of $19.2 billion, and paid dividends of $15.2 billion. Its cash balance decreased by about 6 percent of the cash generated from operations. Procter & Gamble paid 46 percent of its net income as dividends, and its depreciation to capital expenditures ratio was 100 percent, indicating a continuing commitment in this area.

Again, this brief review of the cash application areas illustrates how companies have different strategies for using the cash generated by their operations.

Historically, operations managers have been concerned with the income statement because of their focus on sales and product costs—the heart of most income statements. On the other hand, finance and accounting managers focus on the balance sheet because their primary concern is with the organization’s assets and liabilities. It appears a logical meeting place for these functions is with the cash flow statement, which provides the links between the income statement and the balance sheet.

Accounting and other finance managers play an essential role in cash flow management. They must do the forecasting, participate in resource allocation decisions, and monitor and report on results. However, operations managers play an important role, and the companies that actively and effectively integrate operations and finance functions will achieve increased cash flows.

Cash flow management should not be confined to business organizations. Governments, at the local and national level, are rediscovering the need for better cash management. Being “asset rich” sounds attractive, but if being “cash poor” accompanies it, most businesses would be better off not going that route.

It will be interesting to see how companies deploy their available cash for future investments. A survey by CFO magazine reports that finance executives are increasingly optimistic and welcome 2011 as a year to “loosen their purse strings” (O’Sullivan 2011). Chief financial officers in Asia are the most optimistic, those in Europe are the least optimistic, and those in the United States fall in the middle.

The larger companies plan to hire more workers, both in offshore and domestic locations. In addition, they plan to spend nearly 9 percent more on capital expenditures, about 5 percent more on technology, and 4 percent more on research and development. Smaller companies will continue to struggle because of credit constraints. Banks still are reluctant to lend to smaller companies, so operations managers will have to continue to be diligent in their use of company resources.

The stage is set. If businesses are going to invest in expansion, operations managers will have another opportunity to demonstrate their critical role in cash flow management. They will be under continued pressure to manage working capital—especially inventory—and capital equipment. But it’s always been that way, hasn’t it?

  1. Crandall, Richard E. and Karen Main. 2002. “Cash is King,” APICS magazine. Vol. 12, No. 1, P. 36–40.
  2. Marketwatch.com. Accessed February 5, 2011.
  3. O’Sullivan, Kate. 2011. “Back in Business: While caution predominates, CFOs are starting to have a good feeling about the year ahead,” CFO.com.
  4. Thompson, James H. and Thomas E. Buttross. 1988. “Return to Cash Flow,” 
    The CPA Journal, Vol. 58, No. 3, P. 30–37.
  5. Wampler, Bruce, Harold Carl Smolinski. 2009. “Making stronger statements: Cash flow and income,” Strategic Finance, Vol. 91, No. 4, P. 43–49.
  6. Wikipedia.com. Accessed February 5, 2011.

Richard E. Crandall, PhD, CFPIM, CIRM, CSCP, is a professor at Appalachian State University in Boone, North Carolina. He may be contacted at crandllre@appstate.edu or (828) 262-2034.

For a free list of more than 50 annotated references on this topic, email the author at crandllre@appstate.edu.

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