Cash is the lifeblood of a business, and a business needs to generate enough cash from its activities so that it can meet its expenses and have enough left over to repay investors and grow the business. While a company can fudge its earnings, its cash flow provides an idea about its real health.
Key Takeaways
- Cash management encompasses how a company manages its operations or business activities, financial investments, and financing activities.
- A company has to generate adequate cash flow from its business in order to survive, meaning it is able to cover its expenses, repay investors, and expand the business.
- In addition to generating cash from its activities, a business also needs to manage its cash situation so that it holds the right amount of cash to meet its immediate and long-term needs.
Cash Is King
By generating enough cash, a business can meet its everyday business needs and avoid taking on debt. That way, the business has more control over its activities. In a situation in which a business has to take on debt to meet its expenses, it is likely that its debtors will have a say in how the business is run. If they have contrary opinions to the management’s, that could be an impediment to the way management executes its vision for the business.
Without generating adequate cash to meet its needs, a business will find it difficult to conduct routine activities such as paying suppliers, buying raw materials, and paying its employees, let alone making investments. And it should have sufficient cash to pay dividends and keep its investors happy. Some companies also use their cash to engage in share buybacks to reward investors.
Improving Cash Management
Even if a company is making a profit by making more revenue than it incurs in expenses, it will have to manage its cash flow correctly to be successful. A company’s cash flow is tied to its operations or business activities, to its investment activities (such as the purchase or the sale of capital equipment), and to its financing activities (such as raising debt or equity funding or repaying such funding). The cash that a company generates from its operations is tied to its core business activities and provides the best opportunities for cash flow management.
Areas that offer possibilities for better cash management include accounts receivable, accounts payable, and inventories. If a company were to grant credit indiscriminately, without ascertaining the creditworthiness of its customers, and not follow up on tardy payments, that would lead to a slower and smaller inflow of cash, as well as unpaid bills. That is why it is important to have a credit policy and follow up on tardy payments. On the other hand, when it comes to accounts payable, it is a better approach to cash management to pay suppliers later rather than earlier. As well, it is important not to have too much cash tied up in inventories but to have on hand just enough inventories for the immediate needs of the business.
Profits don't tell the whole picture since a company can find ways to make its earnings look better. But with cash flow, the firm's true wellbeing is on the table.
Striking the Right Balance
There is a balance between having too much cash on hand, out of precaution, and having an inadequate supply. If a business has too much cash, it is missing out on opportunities to invest the cash and generate additional earnings. On the other hand, if it doesn’t have an adequate supply of cash, it will have to borrow the money and pay interest or sell off its liquid investments to generate the cash it needs. If the business expects to generate a better return on its investments than it pays in interest on its borrowings, it might decide to invest its surplus cash and borrow any additional money it needs for its activities. In analyzing a company’s balance sheet, certain ratios such as a firm’s acid-test ratio or the ratio of its most liquid current assets(including cash, accounts receivable, and marketable securities) to its current liabilities provide an idea about its cash management. While a ratio of greater than one indicates a healthy current assets situation, a very high ratio could indicate that the firm holds too much cash or other liquid assets.
FAQs
Effective cash flow management ensures a business can meet its financial obligations, maintain liquidity, and seize growth opportunities. It provides the foundation for making informed decisions, attracting investors, and ultimately driving long-term success.
Why is cash management key to business success? ›
Cash is the lifeblood of a business, and a business needs to generate enough cash from its activities so that it can meet its expenses and have enough left over to repay investors and grow the business. While a company can fudge its earnings, its cash flow provides an idea about its real health.
What are the benefits of cash management? ›
Effective cash management helps a business pay its bills on time, avoid too much debt, and use its money wisely for growth. On a daily basis, it involves watching cash flow, keeping track of money owed and bills, and using tools to manage money well.
Why is cash management important in decision making? ›
The Importance of Cash Management:
Effective cash management ensures that a company has enough cash reserves to cover these obligations promptly, avoiding liquidity crises. Risk Mitigation: Fluctuations in cash flow, unexpected expenses, or economic downturns can pose significant risks to a company's stability.
Why is cash control extremely important for a business? ›
An effective cash management control system is important for the long-term success of a business. It reduces the amount of idle cash in a business and ensures that the cash is being put to productive use.
What is the main objective of cash management? ›
As Modern Treasury puts it, cash management is the monitoring and maintaining of cash flow to ensure that a business has enough funds to function. It is a fundamental practice of business operations that plays a crucial role in maintaining financial stability and supporting sustainable growth.
Why is it important to manage cash flow in a business? ›
Understanding and managing your business cash flow can help you stay resilient in uncertain times and adapt quickly to changes such as rising prices and supply chain issues. From mitigating financial risks such as late and missed payments, to helping you spot investment opportunities.
What is the role for cash management? ›
A cash manager performs and evaluates monetary transactions for an organization. The cash manager's primary purpose is to ensure accuracy and optimization of an organization's spending, earnings and budget. They may create and analyze financial reports, projections and strategies.
What are the big three of cash management? ›
The "big three" of cash management include C) accounts receivable, accounts payable, and inventory.
What are the basic principles of cash management? ›
The basic principles of cash management include a comprehensive understanding of cash flow, choosing assets and investments wisely and tracking their returns. Efficient accounts receivable and accounts payable processes are also important.
Cash management is made up of four elements: (1) forecasting, (2) mobilizing and managing the cash flow, (3) maintaining banking relations, and (4) investing surplus cash. Forecasting can be defined as the ability to calculate, predict, or plan future events or conditions using current or historical data.
What is the conclusion of cash management? ›
Conclusion. In short, a cash management system records and tracks cash transactions. It facilitates multiple crucial financial analyses that help ensure the company's financial health. The main benefits of the cash management system are increased productivity and profitability.
Why is cash management mandatory? ›
Cash management is required in order to match cash outflows with cash inflows. The financial manager should ensure that there is parity between the two. When cash outflows are greater than inflows, proper cash planning is needed; otherwise, the firm will have to deal with the possibility of insolvency or closure.
Why is cash management important to a small company's success? ›
Why is cash management important to my business? When it comes to creating and sustaining a company's financial stability, cash management is a key component. Since “cash” is the primary asset used to pay obligations (whether you're an individual or company), it must be managed accordingly to maximize earnings.
What are the advantages of cash management? ›
Cash management in banks helps with better forecasting, reduced risk, more efficiency, increased liquidity, lowered expenses, and enhanced customer service.
Why is cash better for business? ›
"Paying in cash typically saves the small business owner between 2% and 3% of the transaction price in interchange fees. Interchange fees are the fees charged by the bank, the processing company and card network to process a credit or debit card transaction," Johnston said.
Why is the cash management model important? ›
Efficient cash flow management allows a business to optimize its working capital. By minimizing the time between receiving revenue and paying expenses, a company can improve its operational efficiency and reduce the need for external financing.
Why is cash planning important for a business? ›
Effective cash flow planning and management are essential for both short-term liquidity and long-term financial stability. By understanding the significance of cash flow in finance and implementing sound financial strategies, businesses can ensure optimal operations and long-term success.
What is the motive of cash management? ›
The transaction motive refers to holding cash to meet anticipated payments whose timings is not properly matched with cash receipts. The Precautionary Motive : It is the need to hold cash to meet contingencies in future. It provides a buffer to meet some unexpected emergency.
What is the advantage of cash business? ›
Cash means immediate payment and value, so the extra step of waiting for transactions to process is removed entirely from the equation. Transaction fees and third parties are also eliminated. You will have cash in hand immediately so no middle men or additional processing is required.
