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Bookkeeping – Controlling Cash (Lesson 48)

Lesson 48

In small business, cash is almost always the number one issue.  There is simply never enough.  This is primarily attributable to growth.  Growth requires both physical assets to produce more and expansion of accounts receivable.  Technically the expansion of accounts receivable is the economic equivalent of lending cash.  So if accounts receivable grows $50,000 in one year, the business has lent the customers $50,000.

To offset this cash absorption from growth the bookkeeper must diligently control the cash.  Controlling cash requires three elements.  First are good management policies to prevent impulse buys or unproductive expenditures.  Secondly, a well-organized cash ledger system to easily monitor the cash status and coordinate cash disbursements for both vendors and payroll.  Finally, good communication between the accounting department and the owner related to tracking cash is required.  The sections below go into more detail about each of these three elements in controlling cash.  

Cash Policies

Most small businesses do not have written policies, never mind having written policies for cash.  But there should be a set of written guidelines for cash control endorsed by the Certified Public Accountant and signed by the owner.  Policies can be updated as the company grows, but good policies should exist.

Cash policies are customarily the result of the business plan.  Good plans indicate the maximum growth rate over a given period of time.  Strong growth rates of 10 to 20% per year will pretty much absorb all profits generated during the same time period.  Hyper growth rates of more than 20% will require additional capital contributed by owners to fund the expansion of accounts receivable and to finance the accounts payable.  Again, profits of 12% cannot fund a 15% increase in sales revenue.  Ultimately, it will create insolvency issues.

So a policy should be in place to control sales volume to reduce the impact on cash.  I know it this seems counter productive; but a 12% growth rate is outstanding.

Other policies address expenditures of cash include:

  • Project Funding – Taking on additional volume of work often requires seed money from working capital. An example is a new home builder purchasing additional lots to build houses.  A good policy may indicate the minimum excess cash balance to purchase an additional lot.  See Construction Industry for more information.
  • Equipment Purchases – Unlike in the past, banks no longer finance 100% of the purchase price of a fixed asset. In modern practices, significant deposits at time of purchase are necessary to obtain financing.  Often the deposits exceed 25% of the purchase price.  So a simple $10,000 piece of equipment requires $2,500 of cash.  This high deposit requirement consumes cash quickly.  Again, the only two sources for this cash is either greater profits or additional capital contributed by the owner.
  • Collection Procedures for Aged Receivables – When receivables are paid, cash increases. Unpaid invoices equal cash unavailable.  Aged receivables should have a collection process including certified letters, legal notices and finally legal process to obtain a judgment.  Go to Accounts Receivable Management for guidance.
  • Preference of Outlays – A policy should exist that clearly identifies priority of cash outlays. In general, cash should be directed towards production based expenditures then general operational expenses.  Frugality for any other cash outlay is required.  Expenses such as marketing, advertising; meals and entertainment, and even training should be discouraged so cash is available for growth.

Well Organized Cash Account Layout

The chart of accounts identify the structure of accounts.  For cash accounts, consider the industry, size and uses of cash to lay out a well-organized cash account structure.

For retail sector industries, a cash account is specifically designed to purchase products.  Another is used for operations and a third is restricted to all payroll costs.  So a retail chart of account (cash accounts section) will look like this:

            Chart of Accounts (Cash Accounts)
                                 Retail
Petty Cash: (Parent-Child Account)
.        – Office Cash
.        – Register # 1
.        – Register # 2
Checking – Inventory (Bank Account)
Checking – Operations (Bank Account)
Checking – Payroll (Bank Account)
Checking – Restricted (Bank Account)

The restricted account is designed to receive excess working capital to fund income taxes, fixed asset purchases and growth.

Unlike retail, a service based operation may emphasize payroll accounts, one for production and another for management.  A third checking account is used for normal operating expenditures.

The key to a well-organized cash account structure is the production purpose.  It is not unreasonable to have several accounts dedicated to a purpose restricting the outflows of cash.  This is a good control procedure.  Allow me to illustrate.

A new home builder has two project managers.  Each project manager has a debit card to use for purchases as necessary.  Examples of purchases include project materials, equipment rental, fuel; transportation repairs and maintenance, and small tools.  Each card is assigned to its own bank account to separate the two project manager’s expenses.  This allows the owner to independently monitor the two project managers.

This is an example of the company’s cash account structure:

                        ABC Inc.
     Chart of Accounts (Cash Accounts)
Petty Cash (Office)
Project Checking: (Parent-Child Account)
.        – Construction Checking – Bank Account (Payment of vendors/subs)
.        – Project Management – SSM (Debit bank account only for Steve)
.        – Project Management – BER (Debit bank account only for Bart)
.        – Owner’s Cash Advance (Not a bank account, cash used for discounts)
Operational Checking
Payroll Checking
Restricted (Customer deposits and taxes)

The size of the business operation also has a bearing on the account structure and number of accounts.  Smaller businesses with revenues of less than one million per year can easily address their day-to-day operations with two checking accounts (operations and payroll) and one petty cash account.  Whereas a large operation like a dealership will require separation of accounts based on purposes.  For example there may be a separate checking account for each department (new and used, service, parts; finance and insurance).

Another example of cash control account structure is in apartment complex operations.  Often there are several escrow accounts and trust accounts to maintain legal and loan contract compliance.  Again, a well-organized cash account structure reduces unnecessary spending and impulse buys.  It guides management towards production.

Communication

I can’t emphasize enough the importance of this step.  The better bookkeepers lets the owner know daily the status of cash.  Some send an e-mail with each account’s status, projected receipts and disbursements.  In addition the bookkeeper provides the unrestricted balance.  I would encourage an e-mail daily with this information.

Of course communication is a two-way requirement.  So ask questions such as:

  1. Are there any unplanned expenses in the foreseeable future?
  2. What is the next major asset purchase and projected date?
  3. Will production ramp up necessitating additional cash?

If management/owner identify an issue, plan out cash for the upcoming quarter as explained in Tracking Cash – Lesson 46 and forward the results to the owner.  Ask the owner to confer with his CPA about utilizing cash for the particular outlay.  The idea is to get the owner to think twice before using cash for these purposes.  Cash consumption makes your job more difficult because cash provides flexibility in addressing business needs.

A word of caution: owners frown upon advice from bookkeepers as often they have passion for their ideas and how they want to spend the money.  Your job is to keep them informed by reporting cash status frequently and tracking cash.  Keep the collaboration professional and simply remind him of the increased risk of inability to meet payroll and pay bills in a timely fashion.

Summary

Controlling cash is essential to maintaining solvency.  This is even more important in a fast growing small business.  Unfortunately the profitability of the business is often less than the growth rate of the business.  Therefore working capital, specifically cash, is quickly depleted.  There are several steps a business can take to minimize this effect.

First, create a set of cash policies to eliminate and reduce impulse purchases or unproductive expenditures.  Include growth maximums to greatly reduce siphoning cash into other forms of assets.  Secondly, create a well-organized set of cash accounts to match the respective sector, industry and size of the company.  Finally, communicate with the owner the status of cash and the expected inflows and outflows weekly.  Act on Knowledge.

If you have any comments or questions, e-mail me at dave (insert the usual ‘at’ symbol) businessecon.org.  I would love to hear from you. If interested in my services as an accountant/consultant; click on ‘My Services‘ in the footer of this article.

 

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About David J Hoare (414 Articles)
I spent 12 Years as a Certified Public Accountant, Over 20 Years of Practice in Accounting and Consulting, Controller in Management of Closely Held Operations, Masters of Science in Accounting, Prepared over 1,000 Business Tax Returns and Hundreds of Individual Returns