Cash management as the word suggests is the optimum utilization of cash to ensure maximum liquidity and maximum profitability. It refers to the proper collection, disbursement, and investment of cash.
For a small business, proper utilization of cash ensures solvency. Hence, cash management is a vital business function; it is a function that manages the collection and utilization of cash.
Just like a ‘no cash situation’ in our day to day lives can be a nightmare, for a business it can be devastating. Especially for small businesses, it can lead to a point of no return. It affects the credibility of the business and can lead to them shutting down.
Hence, the most important task for business managers is to manage cash. Management needs to ensure that there is adequate cash to meet the current obligations while making sure that there are no idle funds. This is very important as businesses depend on the recovery of receivables. If a debt turns bad (irrecoverable debt) it can jeopardize the cash flow.
Therefore, cash management is also about being cautious and making enough provision for contingencies like bad debts, economic slowdown, etc.
In an ideal scenario, an organization should be able to match its cash inflows to its cash outflows. Cash inflows majorly include account receivables and cash outflows majorly include account payables.
Practically, while cash outflows like payment to suppliers, operational expenses, payment to regulators are more or less certain, cash inflows can be tricky. So the functions of cash management can be explained as follows :
Higher stock in hand means trapped sales and trapped sales means less liquidity. Hence, an organization must aim at faster stock out to ensure movement of cash.
An organization raises invoices for its sales. In these cases, the credit period for receiving the cash can range between 30 – 90 days. Here, the organization has recorded the sales but has not yet received cash for the transactions. So the cash management function will ensure faster recovery of receivables to avoid a cash crunch.
If the average time for recovery is shorter, the organization will have enough cash in hand to make its payments. Timely payments ensure lesser costs (interests, penalties) to the organization. Receivables management also includes a robust mechanism for follow-ups. This will ensure faster recovery and it will also assist the business to predict bad debts and unforeseen situations.
While receivables management is one of the primary areas in the cash management function, payables management is also important. Payables arise when the organization has made purchases on credit and needs to make payments for the same within a fixed time.
An organization can take short-term credit from banks and financial institutions. However, these credit facilities come at a cost and therefore, an organization must ensure that they maintain a good liquidity position; this will help in timely repayments of debts.
While planning investments, the managers need to be very careful as they need to plan for future contingencies and also ensure profitability. For this, they must use efficient forecasting and management tools. When the cash inflows and outflows are efficiently managed it gives the firm good liquidity.
Avoiding cash crunch, insolvency and ensuring financial stability are the main criterias of cash management. But it is equally important to invest the surplus cash in hand wisely. Despite being a liquid asset, idle cash does not generate any returns. While investing in short-term investments an organization must ensure liquidity and optimum returns.
Therefore, this decision needs to be taken with prudence. Here, the quantum/amount of investment needs to be calculated and decided carefully. This caution is necessary because an organization cannot invest all the available funds. Businesses need to reserve cash for contingencies (cash in hand) too.
Cash management also includes monitoring the bank accounts, managing electronic banking, pooling and netting of assets, etc. So the cash management for treasury can also be a core function. Although for large corporates this function is managed by softwares, small businesses have to monitor it manually and ensure liquidity at all times.
To add, large businesses have access to credit facilities at competitive rates. For small businesses that access is not available. Therefore cash management is vital for them. However, even large corporations need to monitor their systems time and again to avoid a situation of bankruptcy.