Prepare a business letter to share your advice to a client. You will explain complex financial data and discuss the cause and effect of select accounting transactions has on cash balances.
January XX, 2016
(City, ST ZIP Code)
Dear Mr. (CFO’s surname)
In this letter, sound advice is given to the Chief Financial Officer (CFO) of the company on the issue that has led to a constant increase in sales with not much cash to meet the payment needs of vendors and payroll. This is the problem related to cash flow as growing business is known as a ‘cash sponge'. Management of cash flows can be done on basic objectives like investing the surplus to receive a rate of return, accelerating the cash inflows and delaying the cash outflows wherever it could be possible, borrowing cash whenever required and lastly by maintaining an optimum amount of cash that is neither deficient nor excessive (Evans, 2015).
The scenario of cash flows decreasing and sales increasing is the factor analysed by the accounts receivable, which is considered an important element in the working capital. The demands of increasing sales in response to inventory, labour costs will take up the extra dollar to see the cash flowing when the sales are rising. Hence, the company needs to invest more in inventory and labour, but receivables rise along with sales. Therefore, there is more reason to be tied up with receivables (Crfonline.org, 2016). The projection of cash flows is involved more if the company extends its credit to its customers. In this, the company should take account of the collection period for accounts receivable. The tied up money in invoices is not for repaying loans or paying bills. Therefore, there is a requirement for the use of pragmatic assessment of what proportion of accounts receivables needs to comprehend according to average collection period, accounts receivables to sales ratio and accounts receivable aging schedule in the receipt cycle (Bizfilings.com, 2012).
The reports reviewed by the CFO on a daily basis includes cash, accounts receivables and accounts payables. A daily cash flow report should acknowledge all the cash flow events happened during previous business day. There is the requirement to capture cash inflows as receivables and cash inflows/ disbursements, which include payroll checks accounts in accounts payables. Regarding receivables and cash disbursements, the number entered should be positive and negative respectively. The cash balance can be summed up for a day in the equation= Reconciled balance + Total Deposits – Total Disbursements (Wilkinson, 2013). The reason to include receivables and payables on a daily basis is that it accounts in the working capital management as asset and liability respectively. Days Payable Outstanding (DPC) per day analyzes accounts payables whereas Days Sales Outstanding (DSO) per day analyzes accounts receivables. Hence, working capital can be increased and checked on reducing the DSO or increasing the DPO that is holding up payment to vendors and accumulating payments from customers. However, the company always needs to keep business trade-off in mind so that neither early payment discounts are missed out nor company's strict image is formed in front of customers so that they are willing to offer more business (Diffen.com, 2015).
Hope the advice provided in form of solution proves to be useful for the company and solves CFO’s problem to some extent.
Bizfilings.com, (2012). Analyzing the Factors that Affect Your Cash Flow. [online] Available at: https://www.bizfilings.com/toolkit/sbg/finance/cash-flow/analyzing-cash-flow-factors.aspx [Accessed 6 Jan. 2016].
Crfonline.org, (2016). The Trade Creditor's Guide to the Statement of Cash Flows. [online] Available at: https://www.crfonline.org/orc/cro/cro-10.html [Accessed 6 Jan. 2016].
Diffen.com, (2015). Accounts Payable vs Accounts Receivable - Difference and Comparison | Diffen. [online] Available at: https://www.diffen.com/difference/Accounts_Payable_vs_Accounts_Receivable [Accessed 6 Jan. 2016].
Evans, M. (2015). Excellence in Financial Management. Course 4: Managing Cash Flow. [online] Exinfm.com. Available at: https://www.exinfm.com/training/course04.doc [Accessed 6 Jan. 2016].
Wilkinson, J. (2013). Daily Cash Flow Forecast • The Strategic CFO. [online] Strategiccfo.com. Available at: https://strategiccfo.com/wikicfo/daily-cash-flow-forecast/ [Accessed 6 Jan. 2016].