Cooperative boards need cash monitoring tools

Cooperative boards should have policies in place that enable them to keep track of how the current assets of the organization are being utilized.

Every cooperative board of directors is charged with both protecting and utilizing the resources of the cooperative for its members. This simply stated prime directive is far from a simple task.

Balancing the needs of the member with the needs of the cooperative’s balance sheet is a tricky proposition at best. Establishing margins to cover actual costs along with additional net savings that will allow for future growth of services can be difficult, but past performance – together with reasonable expectations and realistic optimism – should drive financial projections.

With the help of the cooperative’s management, boards develop and approve business plans that will meet the organization’s goals. Most planning cycles are conducted annually, creating a budget that anticipates surpluses. New projects offering better services or products are financed along with long-term financing, either with new injections of capital or long-term borrowings. Unrealistic long-term financing projections can seriously interrupt the monthly and daily operations of a cooperative, therefore, understanding how current assets and liability affect the cash to cash cycle is a critical piece of knowledge that any board member needs. Current assets consist of cash, inventories and accounts receivable. Current liabilities include accounts payable for goods and services and the current portion of long or immediate term debt.

The cash-to-cash cycle is a projection of the business function. Raw materials are purchased; value is added to them by labor and equipment to become a finished product. This finished product needs to be inventoried to meet future sales and a sale needs to take place. In most business interactions, no cash has changed hands at this point. Only the dollar amount of the goods has moved from being part of the finished inventory to an account receivable. When the receivable is collected it becomes cash again on the balance sheet. At that point the product has been made, marketed and payment has been received.

The management of the cash-to-cash cycle requires strict attention to insure that proper pricing covers costs (including a profit), inventory control, sales velocity and a  credit policy is in place. Audit and control procedures should not be overlooked to ensure that cash to cash does not become cash to crash. Using short term assets for long term purchases, chasing sales without regard to credit policy, allowing inventories to bloat beyond reasonable levels, the list of potential pitfalls is limitless and requires good tools for monitoring the current position of the cooperative.

One tool is working capital turnover rate. Working capital is defined as the difference between current assets and current liabilities (CA-CL=WC). Dividing sales by the working capital results in the working capital turnover rate, the higher the rate the more efficient the working capital is being utilized. The downside is that if the rate is too high, more risk exists should sales flatten. Understanding the finished inventory turnover rate is a way to monitor how sufficient the level is relative to sales. Costs of goods sold divided by the average inventories will indicate how many times the inventory turns (sells) in a year’s time. Grocery stores should turn inventory 15 to 20 times per year. Ship builders might only turn inventory over once every 5 to 10 years. Which organization would need a higher level of working capital?

Once sold – if not for cash – the asset becomes an account receivable. Still considered a current asset, but just not as tangible as cash or inventory. The ability to collect receivables from customers is very important because of the investment the organization has made in adding value to raw materials. The accounts receivable turnover rate is an excellent method for the real value of this current asset. For credit sales divided by the average (monthly or annual) accounts receivable, the rate should correspond to the cooperative’s credit policy. For example, if payment is expected every thirty days, the turnover rate should be 12 times per year. If out of policy conditions exist, another method to better understand the true value of accounts receivable is to inspect the ledgers.

Business happens in real time and new challenges develop every day. Having policy controls in place so that cooperative management is fully aware of and is reporting on will enable the organization to avoid financial embarrassment due to poor cash-to-cash management.

Michigan State University Extension educators working with the MSU Product Center’s cooperative development services are available to Center help businesses determine best practices in managing and planning of business cash flow.

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