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 implementing sound cash management practices, businesses can improve cash flow, mitigate financial risks, and position themselves for long-term success and growth. Cash management encompasses various activities all aimed at enhancing a business's financial stability, operational efficiency, and overall performance.
Why is cash management important in business? ›
Importance of Cash Management
Ensures Business Continuity: Having enough cash on hand is crucial for any business to keep running smoothly. Just like a car needs fuel to keep going, a business needs cash to pay for daily operations such as buying supplies, paying employees, and covering other expenses.
Why the management of cash is so important to the survival of a business? ›
Cash doesn't just mean the physical money a business has in notes and coins. It also refers to cash in the bank – in other words, money that is available in the business' bank accounts. The management of cash is very important as cash allows a business to pay its bills.
How is cash management or cash flow important for a business to succeed? ›
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.
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? ›
Ensuring Sufficient Liquidity: The main goal here is to make sure a business always has enough money available to pay for what it needs right away and in the near future.
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.
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.
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.
Why is cash so important? ›
Cash allows you to keep closer control of your spending, for example by preventing you from overspending. It's fast. Banknotes and coins settle a payment instantly. It's secure.
A sustained period of negative cash flow can make it increasingly hard to pay your bills and cover other expenses. This is because your cash flow affects the amount of money available to fund your business' day-to-day operations, otherwise known as working capital.
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.
What are two benefits for a business of managing cash flow effectively? ›
The advantages of managing cash flow are straightforward: You will know where your cash is tied up. You can identify potential bottlenecks and act to reduce their impact on your business. It will assist you in forward planning.
How important is cash management? ›
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. This impacts future growth for the company.
What is the main aim of cash flow management? ›
The objectives of cash flow management are twofold. Firstly, it aims to closely monitor cash transactions and plan capital expenditures to ensure timely payment of obligations. By maintaining an optimum cash balance, businesses can meet payment deadlines, avoid bankruptcy, and maximize liquidity.
What is one reason why cash is important to a small business? ›
The management of cash is very important as cash allows a business to pay its bills. The main cash payments a business makes include: payments to suppliers. payments to employees.
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.
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.
What is the purpose of managing cash flow? ›
Cash flow management is tracking and controlling how much money comes in and out of a business in order to accurately forecast cash flow needs. It's the day-to-day process of monitoring, analyzing, and optimizing the net amount of cash receipts—minus the expenses.
What are the benefits and importance of cash? ›
Cash allows you to keep closer control of your spending, for example by preventing you from overspending. It's fast. Banknotes and coins settle a payment instantly. It's secure.
