What is Cash Management and How Does it Work? (2024)

Managing available capital can make sure that a small business stays afloat. Cash management is an integral part of a business. It is part of an organisation that oversees how cash is collected and spent. But cash management is a weakness for many firms for several reasons.

Read on to know about cash management techniques and ways of managing your business flawlessly through it.

What is Cash Management?

The skill of controlling cash inflows and cash outflows is known as cash management. It is an essential step in making sure that any business can survive. For this particular reason, banks and businesses frequently collaborate where banks are given custody of cash assets. However, banks can assist companies with more than just holding cash; they can help them receive money from receivables and pay it forward under payables and other business expenditures.

How Cash Management Works?

Example of Cash Management

Let’s understand this with the help of an example.

Let’s say that this is Company XYZ’s weekly average cash balance report:

As per the report, the total value is Rs. 1,00,000

If the annual interest rate is 12%, the monthly average cash balance would be:

Monthly Average Cash Balance: INR 1,00,000 / 4 = INR 25,000

Therefore, the Monthly Return on Average Cash Balance will be equal to INR 25,000 * 0.01 = INR 250

The business will use this to manage its cash flow.

Types of Cash Management

Here are some of the different types of cash management:

1. Cash Flow from Operating Activities

The cash flow statement of an organisation will show cash flow from operating activities, excluding cash flow from investing.

2. Free Cash Flow to Equity

After capital has been reinvested, cash is still available, known as free cash flow to equity.

3. Free Cash Flow to the Firm

This metric is utilised in financial modeling and valuation.

4. Net Change in Cash

The term “Net Change in Cash” describes the overall cash flow change from one accounting period to the next.

Importance of Cash Management

The primary method used by businesses to settle their financial liabilities is cash. However, money is not the same as value. When all of a company’s assets are considered, it may be worth $1 million, but it might only have $50,000 in cash. Therefore, businesses need to be careful not to spend their money faster than they collect it as receivables.

If a company’s available cash falls short of the amount needed to cover its current liabilities, it might sell its assets to raise money or take out a loan. A business that doesn’t have enough cash to purchase inventory risks potential sales opportunities.

Functions of Cash Management

Listed below are some of the functionalities of cash management:

1. Inventory Control

Inventory management is aided by effective cash management—lower liquidity results from trapped sales, which are indicated by higher inventory. As a result, a company should constantly concentrate on speeding up its cost of being out of stock to enable cash flow.

2. Receivables Administration

To increase sales, a business concentrates on improving its invoices. However, the credit limit and period concerning cash receipts may be anywhere from 30 to 90 days. This indicates that even though the company has every sales record, the funds from such dealings are still pending.

Here, cash management’s job is to ensure that all receivables are paid as soon as possible to avoid a potential cash shortage. It also has a way to keep track of things, providing quick retrieval, and letting the business know what might happen in the future.

3. Management of Payables

This is another essential part of the system of managing cash where discounts and cash credit terms can help businesses.

Objectives of Cash Management

Here are some of the main objectives of cash management:

1. Controls Cash Flow

The most vital objective of a cash management system is limiting your cash outflow as well as accelerating cash inflow. A business owner might always want to increase the amount of cash flowing into the business. However, minimising the cash outflow will result in reduced operational expenses.

An efficient cash management system that is integrated with cash management software will increase your real-time cash visibility which will give you greater control of your cash flow.

2. Efficient Cash Planning

The right cash management system will help you to optimise cash and plan effectively. It helps in planning capital expenditure and determining the ratio of equity and debt to acquire finances. With the right planning, you will have the right amount of liquid cash so that you do not fall short of it.

3. Meet Unforeseen Expenses

The company might have to face certain unexpected circ*mstances like a breakdown of machinery. Having surplus cash will help in coping with this situation in the best manner.

4. Ease of Investment

Cash management helps in the optimum utilisation of available funds by creating an adequate balance between cash in hand and investments. It will help you to invest the idle funds in the right proportion at the right opportunity as it is one of the aims of cash management.

5. Avoiding Insolvency

If companies do not have proper planning for cash management, a situation might arise when the business will be unable to pay its bills. This situation may occur due to a lack of liquid cash or not being able to make a profit from the money available.

How can Cash Management be improved?

Here are some ways how cash management can be improved:

• To understand future cash inflows and outflows, create a cash flow forecast.
• Reduce the time it takes to receive payments by optimising billing and collections processes.
• To reduce cash outflows, monitor and control expenses.
• Improve cash flow by negotiating better payment terms with suppliers
• Streamline payment processes by utilising technology such as online payment systems.
• Create a cash reserve to ensure adequate liquidity in the event of unanticipated expenses or revenue shortfalls.
• To centralise cash management and improve visibility into cash balances and transactions, implement a cash management system.
• Review and update cash management policies and procedures on a regular basis to ensure they are effective and efficient.
• To earn returns on excess cash, consider short-term investments such as money market funds.
• Audit cash management practices on a regular basis to identify areas for improvement and to ensure compliance with regulations.

Basic Principles of Cash Management

Cash management entails managing cash flows and optimising the use of cash resources to ensure that a company has enough liquidity to meet its obligations and achieve its goals. Below are the two basic cash management principles:

1. Accelerating the Cash Receivables Process

Companies must encourage their clients and customers to pay their bills on time by providing them with attractive discounts and other incentives.

2. Keeping Inventory Levels Low

Keeping a larger inventory level can frequently result in a situation where cash is unnecessarily trapped. Even warehouse space is unnecessarily occupied. Companies must devise appropriate techniques and strategies in order to successfully maintain lower levels of inventory.

Cash Management Strategies

Here are some cash management strategies that businesses can use to optimise their use of cash resources:

1. Cash Forecasting and Budgeting

Businesses can better manage their cash flow and anticipate potential shortfalls by accurately forecasting cash inflows and outflows and creating a budget.

2. Negotiating Payment Terms

Negotiate with customers and suppliers to help businesses manage cash flows more effectively. They could, for example, offer early payment discounts to customers or request extended payment terms from suppliers.

3. Efficient Billing and Collection Process

This can help businesses receive payment from customers more quickly and reduce the time it takes to convert accounts receivable into cash

4. Minimise Expenses

Reducing unnecessary expenses can help businesses conserve cash and improve their cash flow. For example, they could negotiate better prices from suppliers or implement cost-cutting measures.

5. Maintain Adequate Cash Reserve

Businesses should keep enough cash on hand to cover unexpected expenses, and emergencies, and to capitalise on unanticipated opportunities.

Benefits of Cash Management

The benefits of cash management are listed below:

• Estimating cash profits is possible, as opposed to only gains from unpaid bills, sales of credit, etc.
• It aids in the detection of cash theft.
• It makes it possible to shorten the cycle of working capital.
• It assists in rewarding those debtors who pay their debts more quickly.
• It quickens an organisation’s activities.

Limitations of Cash Management

1. Poor Cash Flow Management

Companies must be intensely aware of receipts and cash payment timings. They should also ensure that they receive ample amounts to pay forward as payables.

2. Delayed Collection of Cash

Revenue is estimated at the time of a transaction, but money might get delayed for up to 90 days. Companies may record high profits on the basis of their revenue. Still, they can face cash deficits if they have delayed sale collections even after running profits regularly.

Final Word

Learning to adopt proper cash management techniques is essential for every business. They help even the most problematic financial issues to be resolved quickly. Cash management can be performed as per the need and nature of a business. It differs from manager to manager regarding their objectives for the business’s future.

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