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
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.
Why is cash flow management important in business? ›
Cash flow management helps businesses maintain working capital, liquidity, and funds for growth and expansion. Regular monitoring and analysis of cash flows allows businesses to ensure that future cash flows can be projected accurately.
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 impact of cash management? ›
Effective cash management practices contribute to improved financial health, reduced borrowing costs, and increased opportunities for growth and investment. The practice distinguishes itself from treasury management by focusing on short-term cash flow rather than long-term profitability.
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 cash management in business? ›
Cash management is the monitoring and maintaining of cash flow to ensure that a business has enough funds to function. Investments, bill payments, and unexpected liabilities can affect a business' inflows and outflows, and in turn their cash management.
What are the two important benefits of cash flow management? ›
Thanks to solid cash flow management, you ensure you reserve cash for their salaries. Another of the multiple benefits of cash flow management is that it allows you to have a clear forecast of your account payables, which enables you to purchase the raw material or services you need to fulfil your orders.
What is cash management and why it is important? ›
In a banking institution, the term Cash Management refers to the day-to-day administration of managing cash inflows and outflows. Because of the multitude of cash transactions on a daily basis, they must be managed. The ultimate goal of cash management is to maximize liquidity and minimize the cost of funds.
Why should cash be managed? ›
Managing cash is what entities do on a day-to-day basis to take care of the inflows and outflows of their money. Proper cash management can improve an entity's financial situation and liquidity problems. For individuals, maintaining cash balances while also earning a return on idle cash is usually a top concern.
Why is cash more important to a business than profit? ›
In other words, a company can appear profitable “on paper” but not have enough actual cash to replenish its inventory or pay its immediate operating expenses such as lease and utilities. If a company cannot purchase new inventory, it will slowly become unable to generate new sales.
Correct Answer: C) accounts receivable, accounts payable, and inventory. The "big three" of cash management include C) accounts receivable, accounts payable, and inventory. Accounts receivable accounts payable, and inventory makes the cash conversion cycle together, which is a major of cash management.
What is the impact of cash management on business profitability? ›
The findings of this study revealed that there is insignificant but positive correlation between profitability in the business and implementation of cash management practices. So, Implementation of cash management practices helps the business owner to improve their profitability.
What are the 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.
What is cash management in simple words? ›
Cash management, also known as treasury management, is the process that involves collecting and managing cash flows from the operating, investing, and financing activities of a company. In business, it is a key aspect of an organization's financial stability.
What is cash management advantages and disadvantages? ›
Pros and cons of cash management accounts
Fewer accounts to manage. Potentially higher interest rates than standard bank accounts. Benefits similar to checking and savings accounts. Federal insurance on your account, often provided through third-party bank partners.
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.
