The Circular Movement of Money

 

The new lecturer was enthusiastic about learning about managerial issues from his mentor, his former lecturer now holds the position of Head in the new lecturer’s department. He wanted to talk with his mentor about key financial issues, as he had heard about colleges closing departments and even some colleges closing permanently. He sought more about this and what could be done to protect the organisation. His mentor was pleased to hear these questions as they showed his mentee’s interest in such a critical area of management.

 

Cash is the lifeblood of the business

The Head emphasised the urgency of understanding cash flow and likened it to a business's lifeblood. Just as a lack of blood leads to a person's death, a business without cash is bound to perish. This stark analogy stresses the importance of cash flow in a business's survival.

 

Source and application of funds

The discussion continued with the Head stating that an analysis of cash received and spent (or to be received and spent) will show the source and application of the money obtained and spent in running the business. He said the cash situation can be summarised below in the Circular Movement of Cash exhibit. He stressed that if you run out of cash and cannot get it from elsewhere, you will be unable to pay your wages, rent, materials and the like - and the business will collapse shortly afterwards. Managers must plan to work ON, and IN the business to ensure that there will always be money to pay bills as and when required.

 

Exhibit: The Circular Movement of Cash

 

 

Notes:

• In the above ‘Circular Movement of Cash’ exhibit money travels clockwise.
• Leakages (discussed below) occur at all four steps.

 

Cash flow budget

When starting a business, one should always have enough cash for a reasonable period in case sales receipts are lower than predicted, or there are contingencies. Management should prepare a detailed cash flow budget as this identifies future trouble spots, enabling corrective action to be taken well in advance. In addition, cash flow forecasts can be periodically compared with actual figures and variances analysed to revise and update the cash budget.

 

Steps in the Circular Movement of Cash Exhibit

In the exhibit above we see that in Step 1, cash is contributed from one's own money and from elsewhere, including loans. Step 2 indicates that cash is used to purchase goods and services, Step 3 cash is spent to operate the business, and Step 4 cash is received from sales and other sources, including sales of assets. This ‘circular movement of cash’ statement cannot provide all the financial information normally required to run the organisation adequately; as a result, one needs to use together the three key financial statements, which all interrelate, and the notes to the accounts. These three statements are the Cash Flow Statement, the Profit and Loss Statement (sometimes called the Income Statement) and the Balance Sheet (sometimes called the Statement of Assets and Liabilities). The Head stated that he would discuss these Statements in a separate meeting.

 

Leakages

A cash flow leakage refers to the unintended or unnecessary cash outflow from a business's finances. It typically occurs when money is spent on expenses that do not contribute to revenue generation or when funds are lost due to inefficiencies, errors, or oversights in financial management. An example is the purchase of ten widgets, but only eight function. Another is that two students cannot pay the agreed fees. Care is required because there can be fraud or theft internal or external to the organisation at each of the four stages:

 

The risk of insufficient funds

Insufficient funds are an aspect of risk management. The Head said he would also hold a separate meeting on risk management.

 

The Head said that, in summary, it is important to realise that your business will collapse if you do not have the necessary funds to pay your expenses. He reiterated that without payment your employees would not work for you, the phone would be cut off, the property owner would evict you, and you would collapse because you would not be able to pay for your coffee fix.

 

Associate Professor Cyril Jankoff is the Associate Dean, Scholarship at UBSS and a member of the GCA Compliance Directorate