Audit Series Part 1 – Cash is King

Written by Gus A. Molina LMC Audit Manager

In the ever-changing world of business and finance, one truth remains constant: cash is king. Whether you’re a small business owner or a corporate leader, managing cash effectively is crucial to staying competitive and resilient. In this series, we’ll explore the importance of cash flow, strategies to optimize liquidity, and practical ways you can track business operations to ensure they align with industry standards.  From understanding working capital to mastering cash management, join us as we dive into why cash truly rules.

Predicting the Future: Cash Flow Forecasting for Success

Improving cash flow forecasting enhances a business owner’s quality of life by reducing financial stress and enabling better decision-making. Accurate forecasting provides clarity on future cash availability, allowing owners to anticipate potential shortfalls and take proactive measures. This helps avoid financial surprises, preventing last-minute scrambles to cover expenses, and ensures that business decisions—whether related to investments, hiring, or expansion—are based on sound financial projections, avoiding overextension.

Additionally, better cash flow management fosters a sense of control and confidence, leading to greater peace of mind.  Just as a lighthouse safely guides a ship, a cash flow plan will guide a business owner to further success. By minimizing financial uncertainty, business owners can focus more on strategic growth and less on firefighting, freeing up personal time and improving work-life balance. Overall, effective cash flow forecasting leads to a more stable, predictable financial foundation, creating a more fulfilling business experience.

Key Performance Indicators (KPIs) Companies Use to Optimize Liquidity

Some key performance indicators that companies utilize to enhance their liquidity include the Cash Automation Ratio, Operating Cash Flow Ratio, and Quick Ratio.

Cash Automation Ratio: Percentage of cash collection that is automated without manual intervention.

Many companies utilize an ERP system which can track CRM sales and complete inventory management through the module. However, these systems might not be fully integrated into the general ledger reporting system. Companies that run on concurrent systems should look to integrate their systems in order to improve their processes.

Operating Cash Flow Ratio: Cash flow provided by operating activities divided by current liabilities.

This KPI is a good indicator of a company’s ability to pay short-term obligations in a timely fashion. Utilizing the cash generated from its core business, a company can better see how current their obligations are, and if they are in need of additional working capital. The industrial benchmark is that the ratio should be above 1.0, which indicates the company is in a strong position to pay its current debts. Paying obligations late will not only hurt a company’s reputation but might cause the company to incur additional financing charges.

Quick Ratio: Cash plus receivables divided by current liabilities.

In times of economic uncertainty or financial stress, companies might struggle to sell inventory or raise funds. The quick ratio measures liquidity in such situations, indicating whether a company can cover its current liabilities without needing to sell inventory or raise additional capital. Investors, creditors, and auditors often use the quick ratio to benchmark a company’s liquidity against industry standards or against competitors. A higher quick ratio suggests the company is more capable of meeting its short-term obligations, reducing risk for lenders and investors.

Another area that is important to mention in regard to a company’s cash, is the implementing of internal controls to prevent fraud. Fortunately, proactive steps can be taken to mitigate the risk of fraud:

• Segregation of Duties: Ensure that no single employee has control over all aspects of a critical transaction.
• Regular Audits and Monitoring: Conduct periodic internal audits or surprise checks to ensure compliance with financial policies.
• Authorization Controls: Implement an approval process for transactions that exceed a certain threshold. Make sure that multiple levels of review are required before large financial decisions are finalized.
• Whistleblower Policy: Encourage employees to report suspicious behavior anonymously. Create a culture of openness where fraud concerns are taken seriously.

Common Red Flags to Watch for

Handling cash flow and remittances improperly can expose a company to significant financial losses, reputational damage, and even legal consequences. Common red flags to be aware of include:

• Frequent use of manual or unrecorded transactions.
• Unusually high voided or returned transactions.
• Lack of segregation of duties.

By understanding how a company’s cash cycle operates and establishing strong internal controls, a business can reduce its vulnerability to fraud.

If you have concerns about your company’s future cash flow or want to learn more about how to help protect your company from fraud, please reach out to your trusted LMC advisor. We are happy to share our experience and provide white-glove service for all your accounting needs.

Stay tuned for the next article in our series, where we will discuss Accounts Receivable and Revenue.