The circulation of confidence is better than the circulation of money. — James Madison

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Dear Associate :
“ I'm a cash flow guy. If it doesn't make me money today, forget about it”. - Robert Kiyosaki

There is enough and more literature available emphasizing the role that balanced cash flow management can play in ensuring business success. In today’s hi-tech world where data can be sourced on a real time basis, the CFO’s ability to focus on cash flows within the business should not be a great challenge. The purpose of this post is not to emphasize the need and importance of ‘why’ every CFO should focus on cash flow but on ‘how’ incisive cash flow analysis can become an important tool in every CFO’s armory. Some reflections and thoughts in this context are -

Look out for cash profits – having a healthy profitability picture on the income statement is great, however, it is important to ascertain how soon and whether the profits are getting realized in cash on a timely basis. Accordingly, analyzing the linkages between book profits and cash profits and time lag between these is quite important. Invariably, this analysis would lead the CFO to look at components of capital employed and their turnaround efficiencies. The delays in realizing cash profits have a time value, which can erode effective return on capital for the shareholders.

Synthesizing the source of cash inflow – it is quite important to understand the true source of cash inflows. While on an overall operating basis, the picture might appear rosy and reflect a positive net operating cash position, peeling the onion a bit more might reveal some more insights. For an airline business, advance sale of tickets might provide much needed cash but essentially the obligation to provide services would entail a future cash outflow, which needs to be borne in mind. A significant portion of premium collected by an insurance company is towards claims obligations for future. These are examples where cash might get realized in advance but really speaking this cash doesn’t yet belong to the business because the services would be provided in future. Therefore, advance cash collection should be separated from true operating cash collections to understand the quality of operating cash flow balance much better. In a growth scenario, advance cash collection would successfully camouflage operating inefficiencies, which begin to blow up once the growth slows down or reverses.

Careful scrutiny of operating cash outflows – would reveal a lot of useful insights. Is cash getting invested in inventory in anticipation of sales growth? As long as the growth trajectory is in line with the inventory and capacity build up, it should be fine. Reversal of growth trends on billing should help the CFO raise an alert on the need to recalibrate the commitments on capacity building and operating expense outflows.

Investment and operating funding decisions – cash for investment over long term should ideally come from a long term source, unless the operating cash surplus is sufficient to take care of these requirements after making necessary payments towards the cost of capital. Similarly cash for operating needs should ideally get generated through operating sources in order to have a sustainable business. Operating cash flows should be used to first take care of outstanding debt obligations before using them for funding any long term asset creation. This is one area where a lot of infrastructure companies have got themselves into a vicious debt trap. Despite having insufficient operating cash flows, the desire to grow by raising more and more debt would at some point in time spell trouble for the business. Similarly, the current practice of e-commerce businesses to provide deep discounts on their products by using shareholder’s money would at some point in time need course correction. It would be interesting to see how many such e- commerce companies are able to sustain their current business models over long term.

Idle cash – lying in the business generally tends to erode shareholder’s value over long term. Holding some cash for a short term while long term investment plans are getting finalized is fine. If there are no plans to deploy idle cash back into the business by way of organic or inorganic growth, then it would be better to pay back any surplus cash to the shareholders as dividend or even as share buy back. We have examples of companies who are unable to take these decisions on a timely basis. This is one area where the CFO should be able to guide the business and help take correct decisions.

The CFO can effectively use cash flow analysis and draw insights to help improve business performance on one hand and use the inputs to provide early warning signals if the business starts to run away from desired strategic course
May 2015

Dear Associate :

Here is the link above on subject topic with our comment.
“ Very well summarised. However, it is important to have sensitivity model built around the business and financial projections to take care of all the possible scenarios and to what extent one can optimally leverage debt/equity/mezzanine structure. CFO's play very important role in doing risk mitigation around the sensitivity model by plugging this in financial model. @ IxCFO, we play this role for in our CFO Services mandate and navigate the growth in scaling up businesses by putting up this framework.”

February 2015

Dear Associate :

IxCFO continue to refine its practices based on best of financial practices.
In its recent multiple mandates as a part of CFO Services, our CFO Partners developed financial projections for 3-5 years by adopting FAST Standard ( template attached) across sectors like manufacturing, retail, services, e-commerce etc. These models were used for various objectives like fund raising ( equity/debt), budgeting and planning etc.
With these practices, we continue to strengthen our engagement across our offerings with quality approach.

FAST standard which stands for following :

Flexible :
Flexible Model design and modelling techniques must allow models to be both flexible in the immediate term and adaptable in the longer term. Models must allow users to run scenarios and sensitivities and make modifications over an extended period as new information becomes available -- even by different modellers. A flexible model is not an all-singing, all-dancing template model with an option switch for every eventuality. Flexibility is born of simplicity.

Accurate :
Models must reflect key business assumptions directly and faithfully without being over-built or cluttered with unnecessary detail. The modeller must not lose sight of what a model is: a good representation of reality, not reality itself. Spurious precision is distracting, verging on dangerous, particularly when it is unbalanced. For example, over-specifying tax assumptions may lead to an expectation that all elements of the model are equally certain and, for example, lead to a false impression, if the revenue forecast is essentially guesswork.
An overly precise base case only serves to drown analytically more important scenario-based risk analysis and likely ensure the model is incapable of con­ducting Monte Carlo analyses practically.

Structured :
Rigorous consistency in model layout and organization is essential to retain a model’s logical integrity over time, particularly as a model’s author may change. A consistent approach to structuring workbooks, worksheets and formulas saves time when building, learning, or maintaining the model.

Transparent :
Models must rely on simple, clear formulas that can be understood by other modellers and non-modellers alike. Confidence in a financial model’s integrity can only be assured with clarity of logic structure and layout. Many recom­mendations that enhance transparency also increase the flexibility of the model to be adapted over time and make it more easily reviewed.
Fundamental to supporting each of these aims is the root definition of the term analysis– the concept of ‘breaking things up’. This theme must be applied at different levels of Model design: tactically in forming short, simple formulas; functionally to separate timing, escalation, and monetary calculations; and struc­turally at the level of worksheet purpose.

November 2014

The making of CFO : CFO's changing role - A presentation