Business Administration - Basic Skills Guide (SKAT, 1994, 162 p.) Module 3: Cash and Credit Management Cash Management Goal Purpose Vouchers (introduction...) Receipt Invoices Filing Cash Box (introduction...) Family Withdrawals Excess Cash Cash Control The Cash Book Definition Format Cash Check Change of the Year Purpose Tasks Credit Management Purpose Credit (introduction...) Debtors Creditors Conclusion Credit Control (introduction...) Debtors Creditors Cash Planning Purpose Basic Method (introduction...) Limitations The Cash Budget Definition Format (introduction...) Sales Other Cash In Raw Materials Withdrawals Exercise Analysis (introduction...) Cash Shortage Adjustment Poor Cash Appendix A: Cash Book Exercise Appendix B: Cash Budget Exercise

Business Administration - Basic Skills Guide (SKAT, 1994, 162 p.)

Module 3: Cash and Credit Management

Cash Management

Goal

This module explains how to handle cash, how to plan for and how to control cash needs.

Purpose

You need cash to do business. You have to buy raw materials, pay your workers for their labour, meet all other expenses and have some cash for your own purposes.

Without cash no business

It is very important to keep control over the cash situation. To keep control, you should always know exactly how much cash you have in your cash box, how much cash comes in, how much is spent, and what cash is used for. Cash control is done with vouchers and a cash book. Many businesses make a cash budget to help plan and manage their cash needs.

Vouchers

For every cash transaction you should have a voucher. There are several reasons for this:

· Vouchers tell you, how much cash comes in, how much is spent and what cash is used for. So vouchers for cash control are necessary.

· Vouchers explain and document the figures in your cash book.

· Vouchers serve as proof that payments have been made.

· Vouchers are required by law in many countries.

For every financial transaction there should be a voucher

There are two basic types of vouchers: receipts and invoices.

Receipt

The receipt is a voucher for cash which comes in or goes out. With a receipt you can prove that you have paid a certain amount to a certain person. Therefore, there should be a receipt from everyone who has received money from you. Persons who receive money from you can include suppliers of raw materials, bank cashier, or your employees. Your customers will also want a receipt for the cash they pay for your products. A copy of their receipt can be used as the voucher for money coming in.

A receipt should contain the following information:

· The number of receipt,
· The name and address of the person or business who received the money,
· The name and address of the person or business who paid,
· What the money was paid for,
· The amount paid, in figures and in words,
· The place and date of payment,
· The signature of the person who received the money.

An example of a receipt is given below:

Invoices

If your supplier of raw materials comes along with an invoice, you do not need to write a receipt. In this case, the invoice can also be used as a receipt. It is sufficient, when your supplier writes on the invoice that he has received the money and signes this statement (town, date and signature) as it is shown below.

Figure

If you pay the invoice by bank or postal account the voucher from the bank or post office will serve as a receipt.

Filing

In order to retina them, it is a good idea to keep the vouchers in a safe place and in an organised way. You may wish to keep all vouchers in a file according to the date of issue, or the number of the voucher.

Figure

Cash Box

The cash box is for business purposes only. Therefore, only the cash of the business should be stored in the cash box. If money from the business and your own money are mixed up, it is difficult to keep control over the actual financial situation of your business.

According to many experiences it is hard to keep control over the cash situation if too many persons have access to the cash box. For that reason, it is better to have one specified cashier which keeps control over the cash box and all of the vouchers. His motto should be:

Cash (in and out) only in exchange for a voucher

Figure

Family

Cash and materials taken from the business are withdrawals from the business. They are an expense of the business, unless you receive compensation. Keep a record of all cash and materials which are taken from your business by members of your family:

· Record all cash and materials taken by family members,

· From time to time add up the amount of cash and materials taken by family members, and ask for compensation in the form of money, goods or services.

Once, Mr. Garcia gave some cash to his brother to pay for the doctor. A few months later his brother helped him to finance new equipment.

Withdrawals

Decide how much cash you can withdraw for yourself and your family. Try to keep personal withdrawals low. Remember, you must also put aside money to buy raw materials, pay wages, replace old equipment, pay taxes and so forth. In addition you should have cash reserves in case business is slow or you want to expand.

Excess Cash

If you have a large amount of cash in your cash box it might be best to put it in a bank, building society or post office savings account. Money saved in this way can be used as a reserve for emergencies or to buy new equipment.

Cash Control

Even if there is a cashier it is necessary to check the cash every day. Below you find a basic method to do so:

1. Count the cash when business opens in the morning.

2. Each time you receive cash or make a cash payment you should prepare a voucher (receipt or invoice).

3. Count the cash again at the end of the business day.

4. Each day you should add up all the vouchers for cash received and subtract all the vouchers for cash paid out. The difference between cash in and cash out is then added to (or subtracted from) the amount of cash you had in the morning. This figure should correspond to the actual amount of cash in the cash box at the end of the business day.

The procedure is shown by the following formula:

cash at days beginning + cash in - cash out = cash at days end

Figure

If the amount in the above calculation corresponds to the actual amount of cash which you have in your cash box at the end of the day, your cash is in order. If not, there may have been an error when handling the cash or adding up the vouchers and you should find out, where the difference lies.

In the morning of the 15th of January, Mr. Garcia counts his cash. There are LU 85.- in the cash box. In the afternoon, 200 bags of cement are delivered and Mr. Garcia has to pay LU 60.- for it. The driver of the truck gives him a receipt. In the evening. Mr. Garcia counts again the cash in his cash box. There are LU 24 in the cash box. He makes the calculation to control it: 85 + 0 - 60 = LU 25 The result of the calculation (LU 25) does not correspond to the actual amount of cash In the cash box (LU 24). Suddenly Mr. Garcia remembers that he spent LU 1.- for the meal, the driver had in the restaurant. Unfortunately he has forgotten to ask for a receipt. He quickly writes a voucher and closes hie workshop.

The method shown above is very simple, but it has some disadvantages:

· It is tedious and time-consuming,
· It is not suitable as an overview of all transactions,
· It is not suitable for drawing conclusions such as the amount of money spent for raw materials during the last month.

For these reasons it is better to keep a cash book.

The Cash Book

Definition

A better alternative to adding up all the daily vouchers is to keep a cash book. A cash book is simply a book in which all cash transactions of your business are written down.

With the help of a cash book, a supervisor or bookkeeper can analyse the financial situation of your business and give you advice on how to make improvements.

A cash book helps you control your financial situation You should keep a cash book regularly and carefully

Format

If you already have a cash book and are satisfied with your system, there is no need to change it. If not you will find an example below on how a cash book could be kept.

The following hints will help you to make proper use of the cash book:

· On the first line you enter the starting cash. The starting cash is the actual amount of cash in your cash box when you start your cash book or when you start a new page in your cash book.

In the example shown on the next page the starting cash in the cash box on January 1st was LU 80.

Use one line for each transaction. For each transaction include the following information:

· The date. Under date enter the date on which the cash transaction took place, i.e., the date when the cash was actually put into or taken from the cash box.

The date of the sample transaction was ‘5 Jan’.

· The item. Under item briefly describe the transaction.

Mr. Garcia had to pay for a lot of cement: ‘50 Bags of Cement’.

Figure

· Voucher number. Sometimes you need to consult a specific voucher. If the vouchers are filed according to their number they can easily be refound if their number is written in the cash book.

The voucher from the last transaction had the number ‘109’. The present voucher therefore has the number ‘110’.

· Code of account. One purpose of the cash book is to keep control over the cash situation. Another purpose is to prepare the data for the profit and loss statement (see module 5), which allows you to analyse the financial situation of your workshop. In order to relate the cash transactions to the positions of the profit and loss statement, every position of the profit and loss statement is identified with a code and all cash transactions which correspond to that position receive the same code.

The coding system used in the profit and loss statement of module 5 looks as follows:

- Sales (of products and services) .............................................................................	100
- Raw Materials ..........................................................................................................	200
- Working Costs (wages, salaries, social expenses) .................................................	300
- Production Inputs (water, energy, consumables, others) ........................................	400
- Overheads (office, marketing, transports, maintenance,
taxes and fees, interests, others) ...............................................................................	500
- Depreciation (buildings and equipment) ..................................................................	600
- Withdrawals .............................................................................................................	700

Cement is raw material, the code of account therefore is: ‘200’.

· Cash In or Cash Out. The next two columns are for recording whether cash came in or went out. Use only one column depending on whether there was cash in (cash received) or cash out (cash paid).

Mr. Garcia had to pay LU 50 for the cement. He therefore writes in the column of ‘Cash Out’: ‘50’

· Balance. Next you must determine the actual amount of cash there should be in the cash box after the transaction has been completed, that is the balance. To find the balance:

1. Start with the balance from the preceding transaction.
2. Add to (cash in) or subtract from (cash out) the previous balance.
3. Write down the answer in the balance column.

Before paing the 50 bags of cement, Mr. Garcia has LU 80 in the cash box. After paying LU 50 for the cement, he still has LU 30 in his cash box: LU 80 - LU 50 = LU 30

Cash Check

To be sure that the amount of cash in your cash box is the same as the balance in the cash book, you should count the cash in the cash box every day, compare the two amounts and, if necessary, correct your calculation or recording mistakes.

In Appendix A you will find a cash book exercise. You can use it for your own practice.

Change of the Year

Purpose

It is a good idea to control the whole bookkeeping system once a year and to begin every year with new books.

Tasks

At the end of the year the following should be done:

1. Close the cash book: Add up all “cash in” and “cash out” figures for the year and make the following calculation:

If there is a difference, make the calculation again. If the same difference remains, control all the figures for “cash in”, “cash out” and “balance”.

2. Make sure that the amount of cash in the cash box corresponds to the final balance. If it does not, you should investigate to find out why there is a difference. Did you forget to record some cash transactions? Is the arithmetic correct? Is some money lost?

3. Prepare a profit and loss statement (see module 5) for the preceding year and determine the Net Profit (or Loss).

4. Determine the appropriate amount of withdrawals. Make the end of year withdrawals and enter the amounts in the cash book and profit and loss statement. Determine the retained profit (or loss).

5. Start the New Year with a new cash book.

Credit Management

Purpose

If your customers do not pay for their tiles, you would not be able to pay your workers or pay for raw materials. Very soon your workers would look for new jobs, your suppliers would no longer supply your raw materials and finally, production would stop. If your business is to succeed, you must manage the credit you give to your customers, just as you must manage the credit you receive from your suppliers.

Credit

Sometimes, your customers will not be able to pay immediately, although they take home the goods they have purchased in your business. That means: You give credit to your customers. The customers to whom you have given credit are called debtors.

Sometimes, you do not need to pay immediately for the things you purchase with your suppliers. Your suppliers may also give you credit. The suppliers who have given you credit are called creditors.

There is an important difference to regular credits from a bank: No interest is paid.

Debtors

You should keep the number of your debtors as low as possible. When you give credit your cash is tied up. You receive no interest and the value of the credit given may be reduced by inflation. By the time your debtors pay their bills, the value of the money may be less than when you gave the credit.

Creditors

You should not have many creditors either, and always be able to pay your debts within the agreed upon time limit.

Conclusion

The following two rules should form the basis of your credit management system:

1. The number of your debtors and creditors should be kept as low as possible. 2. The amount of creditors should not be higher than the amount of debtors.

Credit Control

It is possible to have a profitable business that has no cash because your customers have not yet paid for the goods they received on credit. For this reason you need a credit control system.

Debtors

Your debtors can be controlled in an efficient way by using two files:

· Customer invoice file. When you write an invoice keep one copy in the customer invoice file. File the invoices in numerical order (voucher no. or date). In this file you will always be able to see who owes you how much. From time to time look through the old invoices and write reminders to the customers who have not yet paid their invoices, or visit them and collect the amount owed to you. When a customer only pays part of an invoice, make a note on it and leave it in the file.

· Paid customer invoices. When a customer pays the full amount of the invoice, stamp or write “paid” on your copy of the invoice. Remove this invoice from the file ‘customer invoice file’ and put it into a tile labelled ‘paid customer invoices.

Creditors

Your creditors can be controlled by the same way:

· The supplier invoice file. Use this file for invoices which you have received from suppliers for goods or raw materials.

· Paid suppliers invoices. Once you have made payment, write “paid” on the invoice, stating when and by whom payment was authorised and confirming that the details have been checked. Transfer the invoice to the file ‘paid suppliers invoices’.

Cash Planning

Purpose

Sometimes a business will have a large amount of cash and sometimes there will be almost no cash in the cash box. Though this is a normal situation, it is one that calls for careful planning to make sure that there is always enough cash to pay the workers and buy raw materials. Always make a cash plan before ordering equipment or raw materials and make sure that there is enough cash to pay for them.

You should plan your expenses

Basic Method

A basic method to prevent cash shortages is the following: Always keep a certain amount of cash as reserve. When a payment leads to a situation where you have to make use of this reserve, you make the following:

1. Write down the most important expected expenses and incomings of the immediate future (one to three months).

2. If you see that there is no danger of a cash shortage you can pay cash without worrying. If, however, you see that a cash shortage is likely to occur you should act immediately. Try to find an acceptable solution for everybody through negotiations.

To determine the amount of the reserve, start with a small amount, e.g., one month’s expenses. If you always have a lot of cash in the cash box, the amount of reserve is too high and might be reduced by puting some money in a bank account. If you often run into situations with cash shortages, the amount of reserve is too low. After a certain amount of experience, you will find out, what amount of reserve is best for you.

Attention If you frequently run into a cash shortage, and cannot manage to keep a sufficient cash reserve, you may have a severe problem. Below (‘Poor Cash’), you will find further information.

Mr. Garcia always trys to keep at least LU 50 in his cash box. On the 16th of March 1992, he has LU 50 in his cash box. In other words, he is on the limit of his cash reserve. Therefore, he decides to estimate future income and expenses to prevent a future cash shortage:
Date	Item	In	Out	Balance
16.3.92	Starting Cash			LU 50
25.3.92	Wages		LU 30	LU 20
10.4.92	Raw Material		LU 40	(LU 20)
12.4.92	Taxes		LU 10	(LU 30)
15.4.92	Sales	LU 100		LU 70
Without a doubt Mr. Garcia will run into a cash shortage by the 10th of April! The cash plan he made shows that he will need LU 20 more than he will have on 10th April, and that he will need a total of LU 30 more than he will have by the 15th of April. The tax payment cannot be delayed and the raw material must be paid for on delivery. Mr. Garcia looks at his production plan and sees that he still has enough raw material to produce until the 24th of April. He decides to postpone the planned purchase of cement, to prevent a cash shortage. He makes a new cash plan to see if this will solve the problem of the anticipated cash shortage. His new cash plan looks like this:
Date	Item	In	Out	Balance
16.3.92	Starting Cash			LU 50
25.3.92	Wages		LU 30	LU 20
12.4.92	Taxes		LU 10	LU 10
15.4.92	Sales	LU 100		LU 110
24.4.92	Raw Material		LU 40	LU 70
The new cash plan shows that Mr. Garcia can continue production, pay his workers and his taxes and still have no cash shortage.

Limitations

The basic method may lead to a high cash reserve which is only used exceptionally. In other words, normally there is too much money in the cash box and it cannot be used for other purposes. When this becomes a problem, you should use a more sophisticated method - the cash budget. The next section tells you how to prepare such a cash budget.

The Cash Budget

Definition

The cash budget is a plan which shows the future movements of cash - the cash flow - in and out of the business. A cash budget is a projection - a look into the future. Some amounts will be known, but others will have to be estimated. The following is an example of a simple cash budget:

Figure

At the beginning of January there are LU 50.- in the cash box. The incoming cash from selling products is estimated to be LU 100.-, the cash flowing out of business through expenses is estimated to be LU 60.- Therefore, at the end of January there are still LU 90.- in the cash box. LU 90.-, however, is the amount of cash present at the beginning of February, and so on.

Format

An example of a cash budget format is given on the next side. The following hints will help you prepare and use the cash budget:

Sales

Sales are based on past sales and adjusted for estimated future sales trends. The figure for sales is entered in the field for the month for which the cash for sales is received. When tiles are sold on credit, payment is not received at the time of the sale. Cash payment is received later, when your customers pay their accounts.

Other Cash In

If you expect to receive cash from any other source, for example from selling a machine, enter the estimated amount on the line ‘Other Cash In’.

Figure

Raw Materials

From the products you plan to produce the next six months, you calculate how much raw materials you need for this time. Then you estimate, what batches you have to order at what date, when they arrive and when payment is due.

The cash budget must show cash payment for raw materials when it is expected to be made, not when the order is placed or when delivery is made.

Withdrawals

Estimate how much cash will be withdrawn from the business each month and enter the amounts for each month on the line for ‘Withdrawals’.

Exercise

In Appendix B you will find a cash budget exercise. You can use it for your own practice.

Analysis

The purpose of the cash budget is to have enough cash at all the times. The cash budget is a useful tool to help you plan your cash requirements. A business cannot keep running if it has no cash - even if it is making a profit. For that reason, the “Cash at End” is the information to be analysed:

Cash Shortage

If your cash budget indicates a negative or very small cash amount, such as the ‘Cash at End’ in September as shown in the example above, then you must analyse the situation and take corrective action. Can you postpone delivery of raw materials? Can you negotiate credit from your suppliers? Can you collect credit payments that are due from your customers? Can you borrow money from a bank, or from your family? Some action must be taken so that your business does not run out of cash. On the next page, you will find an example.

Adjustment

If you postpone the investments planned for August and September until November, you can avoid a cash shortage in September.

The cash budget below shows the result of planning to meet the expected cash shortage by post-poning investments until November.

Figure

Poor Cash

If the amount of ‘Cash at End’ is always small and often negative, it is a clear sign of a problem. You should analyse the situation and take corrective action. The problem may be caused by one or more of the following:

· Low profits. The business is not doing well. Cash may be low because profits are low or even negative (then you are in a loosing business). The profit and loss account (see module 5) shows whether the business is making a profit or a loss.

· Too much customer credit. The business may be making a profit, but the profit might be tied up in credit sales that have not yet been paid. The business may need to collect outstanding credit and reduce credit sales. Add up your sales credits and look whether their collection would help.

· Excessive withdrawals. A low cash level can result if the owner or family members take too much cash from the business.

· Stocks of raw materials are too big. The business may have too much money tied up in raw materials. In normal circumstances raw materials should be just sufficient to meet current production needs - plus a little reserve.

Appendix A: Cash Book Exercise

Make a copy of the cash book format and enter the following transactions from Garcia’s Tile Factory:

1 Jan 91	Start of the new year. There are LU 85 in the cash box.
15 Jan 91	Purchase: 200 bags of cement for LU 60. Voucher no. 100.
18 Jan 91	Purchase: 5 tons of sand for LU 10. Voucher no. 101.
23 Jan 91	Pay: water and electricity fee, LU 3. Voucher no. 102.
13 Feb 91	Cash Sale: Mr. Brown pays LU 80 for tiles. Voucher no. 1002.
3 Mar 91	Purchase: plastic sheets for LU 1. Voucher no. 105.
25 Mar 91	Pay: workers’ wages, LU 30. Voucher no. 106.
12 Apr 91	Pay: maintenance (repair moulds), LU 10. Voucher no. 108.
22 May 91	Cash Sale: Mr. Grey pays LU 150 for tiles. Voucher no. 1003.
20 Jun 91	Pay: workers’ wages, LU 35. Voucher no. 109.
3 Jul 91	Cash Sale: Mr. Mwangi pays LU 100 for tiles. Voucher no. 1004.
15 Jul 91	Purchase: new moulds, LU 40. Voucher no. 110.
18 Aug 91	Purchase: office supplies, LU 1. Voucher no. 111.
23 Aug 91	Pay: manager’s salary, LU 40. Voucher no. 112.
6 Sep 91	Cash Sale: an NGO pays LU 100 for tiles. Voucher no. 1005.
25 Sep 91	Pay: workers’ wages, LU 40. Voucher no. 113.
3 Oct 91	Pay: The News’ LU 8 for an advertisement. Voucher no. 114.
16 Oct 91	Purchase: 200 bags of cement for LU 60. Voucher no. 115.
16 Oct 91	Purchase: 5 tons of sand for LU 10. Voucher no. 116.
31 Dec 91	Withdrawal: Mr. Garcia withdraws LU 40. Voucher no. 117.

The answer to the cash book exercise is given next.

Figure

Appendix B: Cash Budget Exercise

Make a copy of the cash budget format and enter the following transactions from Garcia’s Tile Factory:

· The cash budget is for the period from January 1992 to June 1992.

· The ‘Cash at Start’ on the 1st of January is LU 50.

· The sales manager estimates that future sales will be:

· January: LU 100
· February: LU 50 cash sales (directly paid), LU 50 credit sales (paid one month later).
· March: LU 110
· April: LU 120
· May: LU 140
· June: LU 140

· He plans to pay the following wages to his workers:

· January, February, March and April: LU 40 per month
· May and June: LU 50 per month

· Based on the figures from the sales of tiles, the production manager estimates the cash needed to buy raw materials:

· January: LU 20

· February: LU 40. Moreover, new sand is delivered. It costs LU 30. The invoice says that it must be paid in March.

· March and April: LU 50 per month

· May and June: LU 60 per month

· Overhead expenses are estimated to be LU 10 per month in April, May and June.

· Maintenance expenses are estimated to be LU 10 per month in March and June.

· In June Mr. Garcia withdraws LU 50, and a loan interest of LU 10 is paid.

· In May he plans an investment in new equipment of LU 50. The old equipment will be sold to a friend in June for LU 20.

The answer to the cash budget exercise is given next.

Figure