Cash Management

True Tamplin

Written by True Tamplin, BSc, CEPF®
Updated on September 20, 2021

Why Do Businesses Need Cash Management?

Cash is an important current asset when running a business. Cash is always needed to run a business enterprise.

A reasonable cash balance is always preferred. It should not be less than the demand nor more than the reasonable demand. The lower the quantity of cash, then legitimate needs will disturb daily business routines.

Similarly, holding excess cash is unwise because it can undermine the profitability of the organization.

The cash balance is the most unproductive asset of an organization. However, it is important because it is used to pay liabilities. Thus, it is recommended that a reasonable cash balance be maintained to optimize liquidity and profitability.

What Is Included in Cash Management?

The word cash is used in two senses: first, in a narrow sense referring to coins, currency notes, checks, bank drafts, and demand deposits; and second, in a broader sense.

Cash in the broader sense refers to near-cash assets, including marketable securities and time deposits with the bank. These assets are considered cash in the broader sense because they can be converted into cash easily.

Thus, cash management deals with:

  • Meeting cash disbursement as per the payment schedule
  • Minimizing the idle cash balance

Problems of Cash Management

The following are the major problems that cash management seeks to address:

  1. Controlling the level of cash
  2. Controlling cash inflows
  3. Controlling cash outflows
  4. Optimum investment of surplus cash

1. Controlling the Level of Cash

The basic objective of cash management is to minimize the level of cash balance within the organization. This can be achieved by preparing a cash budget.

2. Controlling Cash Inflows

Once the cash budget is prepared, the financial manager should ensure that a gap does not exist between actual cash inflows and outflows. Due importance must be given to cash collection techniques.

3. Controlling Cash Outflows

Fast collection and slow disbursement of cash are helpful to control cash outflows. Cash collection should be accelerated, while cash disbursement must be as slow as possible.

Outflows can be controlled if a centralized system for cash disbursement is used. Payments must be made on the due date (i.e., not before and not after the due date).

4. Optimum Investment of Surplus Cash

Excess cash is the surplus cash available with the finance manager after meeting all outflows. Surplus cash is the excess cash available over the minimum cash balance. Such excess should be invested in the purchase of temporary (short period) investments.

The excess cash should be invested in securities where the funds are safe and liquid, and the fund should be available whenever required.

Benefits of Holding Cash or Objectives of Cash Management

The following are the main objectives of cash management:

1. Useful in Making Payments According to a Schedule

The main objective of cash management is to ensure that a company’s liabilities are paid on the due date. Payments and purchases may include raw materials, wages, salaries, interest, dividends, taxes, and other routine payments.

2. No Danger of Insolvency

Sufficient cash holdings will increase the goodwill of the organization and ensure that it can pay creditors and taxes on the due date. Hence, there is no danger of insolvency under effective cash management.

3. Positive Relationship with Bank

A reasonable cash balance will be helpful in paying customers on the due date. This means that there is no need to secure bank credit in the form of cash credit, bank overdrafts, and discounting bills.

4. Usefulness of Cash Discount

A reasonable cash balance will benefit large-scale purchases. In particular, payment of large-scale purchases in cash can be useful in exploiting cash discounts.

5. Good Supplier Relations

A good cash balance is always desirable to ensure that suppliers are paid on the due date. This will increase the creditability of the firms, which will yield benefits in terms of the organization’s future profitability.

6. Helpful in Odd Situations

When a firm has a reasonable cash balance, it can exploit odd and unexpected business situations.

For example, deflation occurs when there is a shortage of currency in circulation. In the context of deflation, commodities will be cheaper, and so a firm with a sufficient cash balance can benefit by purchasing commodities and other assets.

Factors Affecting Cash Management or Level of Cash

The following are the factors that affect an enterprise’s cash requirements:

1. Matching of Cash Flows

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.

2. Non-recurring Expenditure

These are the expenses needed to purchase or expand fixed assets. The planning of such projects occurs every few years, and significant amounts of cash are usually needed around these times.

3. Cash-short Costs

These expenses are caused due to cash paucity. The cash budget is a forecast of cash requirements and the specific period over which cash will be needed.

Examples of cash-short costs include the sale of securities, their brokerage, and the cost of borrowings such as interest on debentures.

4. Cost of Excess Cash Balance

When a firm keeps more cash than its reasonable requirement, this will reduce the chances of investing any surplus cash balance. The organization may suffer from a loss of interest, which is known as the cost of excessive cash balance.

5. Management Cost

These are the costs that are incurred for cash management, including salaries and clerical expenses. Management costs are always of a fixed nature.

6. Uncertainty

There are cases when cash inflows may be uncertain (e.g., when payments have yet to be received from debtors). Firms should keep some margin for such emergencies and uncertainties.

7. Repayment of Loans

The firm may be liable to redeem its long-term loans, and this must be kept in mind when estimating cash requirements. In general, long-term loans are repaid by issuing either new shares or debentures.

8. Capacity to Borrow in an Emergency

When a firm has the ability to borrow in emergencies, it can operate with a smaller cash balance.

However, a firm’s borrowing capacity depends upon its relationships with banks, the nature of the fixed assets to be mortgaged, the rate of interest, and the demand and supply of short-term loans.

9. Management Attitudes and Policies

The attitudes and policies of management with regard to liquidity, risk of insolvency, and credit sales are largely affected by cash requirements. Sometimes, management prefers liquidity over profitability, and in such situations, the cash requirement will be high.

10. Efficiency of Management in Managing Cash

When a firm’s management follows and practices the policy of realizing debts on the due date (not before or after) and accelerating payments from debtors, smaller cash balances are acceptable.

True Tamplin, BSc, CEPF®

About the Author
True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True contributes to his own finance dictionary, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, his interview on CBS, or check out his speaker profile on the CFA Institute website.

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