Ocampo: Cash management and cost management leading to business profits

CASH and cash equivalents. This is the first financial item shown on balance sheets audited by independent auditors. It is the most liquid asset and the ultimate working capital that a business wants to grow.

Cash and cash equivalents consist of bills, coins, dated checks of customers and short-term placements such as Time Deposits, made to optimize the use of the excess cash of the business.

Trade Receivables, the most liquid near-cash financial item next to cash, are cash per se only that they still have to be collected from credit customers.

Cash is the beginning and the end of a business cycle – only which it has to be bigger in amount at the end of the said cycle; and to achieve this, the business has to earn profits.

The essence of doing business and earning a profit is simple. Each day, the business converts cash to either an expense or a different kind of asset that will also ultimately become an expense.

Examples of cash becoming directly as expenses are operating expenses such as salaries and wages, rental, office supplies, advertising and promotion, repairs and maintenance, representation and entertainment and taxes and licenses.

Some examples of cash being converted to another kind of asset that will ultimately become an expense are the following:

Inventories

In a manufacturing firm, cash is used to buy raw materials that will show in the Balance Sheet as Raw Materials Inventory. Upon issuance and processing in production, raw materials become part of the product cost and now will be called Finished Goods Inventory.

Finished Goods that are sold will then become expenses and will be called Cost of Goods Sold when presented in the Income Statement.

Prepaid Assets

Prepaid Assets or called Prepayments are advance payments of business expenses before they become due. Examples are Prepaid Rent and Prepaid Insurance.

Prepaid Rent is an advance payment of rentals. When a Rent Contract ends, the Prepaid Rent is converted as a Rent Expense on the month the contract expires and is shown as an operating expense in the Income Statement.

Prepaid Insurance on the other hand is an asset representing an advance payment of insurance premiums usually for a year or more. When a monthly premium becomes due the asset becomes an Insurance Expense for the month.

Property, Plant and Equipment

Property, plant and equipment also called fixed assets, usually consists of land, buildings, office equipment, furniture and fixtures, transportation equipment and machinery and equipment.

They become expenses over their estimated useful lives in the form of depreciation as a result of normal wear and tear. Depreciation is shown as operating expense in the Income Statement.

Expenses do not remain as expenses. Otherwise, there is no sense in doing business. Expenses have to serve a business purpose.

An astute businessman keeps in mind the basic principle of getting rich, that is to always make sure that a peso spent (expense) has to earn and generate a greater amount of peso (revenue) in order to earn a profit. Such is the simple essence of doing a business.

A clear example of the conversion of cash to a different kind of asset and ultimately becoming an expense to earn and generate a greater amount of revenue to earn a profit is the depreciation of machinery and equipment.

Depreciation is an expense to the business resulting from the normal wear and tear of fixed assets such as machinery and equipment. Machinery and Equipment is another kind of asset that is the result of the conversion of cash.

The normal wear and tear of machinery and equipment called depreciation is a necessary expense in order to produce goods for sale. When finished goods are sold, the businessman has to set a selling price higher than all the amount of expenses incurred when the goods were made available for sale; and these expenses include depreciation.

Setting a selling price higher than expenses is equal to profits. Earning profits will enable a business to have more cash at the end of the business cycle. If this is the outcome at the end of each operating period, the business owner will be happy.

Cash and all other kinds of assets converted from cash will become expenses in the future. The higher the amount of assets, the higher the expense, and ergo the higher the revenue should be so as to earn a profit.

The following adages find relevance in reducing operating expenses:

Do more with less

Optimize the use of assets

Spend only on needs and not wants

Any business spending should be evaluated as to whether they will contribute and support revenue generation. Exceptions are spendings that will impact product and service quality and business security. The business cannot and should not compromise quality and security.

Cost Management then is the epitome of Cash Management. It is what brings profit to the business.

***

Joselito R. Ocampo, a Certified Public Accountant, a Doctor in Public Administration and an Entrepreneur, is the Managing Director of JR Ocampo Consulting and Professional Services.

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Thanks to SunStar Pampanga for this second opportunity given me to write and share my thoughts and experience as an accountant and a financial consultant, an entrepreneur and a former public servant loyal to the people I have served for six years as city councilor.

Excellence is our business. The rallying slogan of my Firm, JR Ocampo Consulting and Professional Services. It embodies who I am and my desire to serve clients and the public. I owe this column to the people of the City of San Fernando, Pampanga.

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