Cash management is a need common to both large and small businesses alike. In its simplest terms, cash management is the assurance that today's receivables plus today's account balances exceed today's payables. Failure to practice this business management process guarantees bankruptcy.
Every large organization has a cash management group, sometimes called the treasury. This group's function includes management of such items as investments and borrowing in addition to the organization's daily cash flow. In small to medium businesses (SMBs), usually the chief financial officer (CFO), president, or owner performs the task of cash management.
Regardless of a company's size, the important thing is that cash management is practiced on a regular basis—at least weekly—and with sufficient attention to details. In difficult times, when liquidity is "tight" (at a minimum), it should be performed daily.
Crucial to organizations' successful cash management are the deals they make with their financial institutions for short-term placements and for borrowing funds. Unlike in other countries, in the United States, a bank account that is credited with deposits does not begin to earn deposit interest until three business days have passed. Furthermore, an American business account specifically may not be overdrawn, which necessitates cash management to be the most important activity of a business's financial management.
For all companies—and in particular, public traded companies—major financial statements include the income statement, the balance sheet, and the statement of cash flows. An organization's CFO, accountant, or proprietor will likely share this snapshot of financial performance with lenders, equity investors, and the company directors and key stakeholders.
Surprisingly, most SMBs and large organizations find spreadsheets a useful tool for cash management. The cash management facilities serve as the basis for entries on the spreadsheet. The spreadsheet is easy to manipulate and allows for what-if scenarios and forecasting. Yet cash management for many companies is a mix of financial software and spreadsheets, with the majority of decisions based on spreadsheet manipulations.
Effective cash management requires having a firm handle on the following two areas:
1. Cash inflows
Daily morning and afternoon deposits from the Automated Clearing House (ACH)—where morning deposits are received from local banks and afternoon deposits are received from banks located more than two time zones away—electronic data interchange (EDI) transfers, e-mail notifications, etc.
Forecasted deposits for the day, generated from cash management software. These are based on reliable deposits taken from sales invoice dates plus credit days allowed (e.g., net 30, 2 percent net 10, etc.).
Checks received in the mail.
Over-the-counter cash receipts.
Credit card receipts.
Forecasted deposits based on disputed invoices (i.e., invoices where credit notes may have to be issued) or the "poor payer" category of customers, generated from cash management software.
Investment income.
2. Cash outflows
"Must pay" accounts (e.g., payroll).
Commissions; local, state, and federal liabilities (e.g., taxes, social security, etc).
Payment to liability accounts (e.g., insurance, mortgages, leases, employee travel expenses).
Valuable suppliers that provide payment discounts for early payment.
Suppliers whose limits within agreements can be stretched (e.g., net 30 days).
All bank account balances.
Loan payments due.
Interest payments or term deposits due.
The Price of Cash Mismanagement
When cash flow is tight, cash management helps a company decide who must be paid and whose payment can be skipped for a given week. Mismanagement of cash inflows and outflows will cause a company to face a liquidity crunch. A liquidity crunch forces a company to borrow money at a disadvantage, meaning a company that is in dire need of short-term cash will pay more interest on a loan or line of credit than it would have had it used better cash management techniques.
Poor decisions and practices by a company's financial managers can have disastrous effects on the business too. Following are examples of poor decisions and practices:
Transferring too much of the business's liquid assets into the acquisition of fixed assets, such as machinery or real estate. Monthly commit¬ments must be properly managed by obtaining long-term financing for such large capital investments.
Failing to budget properly. To avoid this problem, construct a spreadsheet with columns that represent weeks or months, and with rows that represent inflows or outflows. Lay out, by month, the known inflows and outflows. Toward the bottom of the sheet, place the less-certain inflows and outflows. Each period's column total (closing balance) should be brought forward to the next column as an opening balance.
Failing to make use of a business line of credit (LOC), or exceeding the LOC limit, resulting in refinancing with factorers. Factorers are organizations that provide funds to a business, using the business's inventory as collateral. A factorer can be a vendor's representative as well, selling on commission. Factorers can also provide cash based on a business's future confirmed receivables. Their rates for lending money are usually higher than bank rates.
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