Learn 100% online from anywhere in the world. Enroll today!

Cash Management

The process of collecting and managing cash flows from the operating, investing, and financing activities of a company

What is Cash Management?

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.

 

Cash Management

 

Cash management is important for both companies and individuals, as it is a key component of financial stability.

Financial instruments involved in cash management contain money market funds, Treasury bills, and certificates of deposit.

Companies and individuals offer a wide range of services available across the financial marketplace to help with all types of cash management. Banks are typically a primary financial service provider. There are also many different cash management solutions for both companies and individuals seeking to get the best return on cash assets or the most efficient use of cash.

 

 

Quick Summary

  • Cash management, also known as treasury management, is a process that involves collecting and managing cash flows.
  • Chief financial officers, business managers, and corporate treasurers are usually the main individuals responsible for overall cash management strategies, stability analysis, and cash related responsibilities.
  • Many businesses fail at cash management and the reasons vary. Typically, a poor understanding of the cash flow cycle, profit versus cash, lack of cash management skills, and bad capital investments are the reasons for failing at cash management.

 

The Importance of Cash

Cash is the primary asset individuals and companies use regularly to settle their debt obligations and operating expenses, e.g., taxes, employee salaries, inventory purchases, advertising costs, and rents, etc.

Cash is used as investment capital to be allocated to long-term assets, such as property, plant, and equipment (PP&E) and other non-current assets. Excess cash after accounting for expenses often goes towards dividend distributions.

Companies with a multitude of cash inflows and outflows must be properly managed to maintain adequate business stability. For individuals, maintaining cash balances is also a major concern.

 

Understanding Cash Management

In an organization, chief financial officers, business managers, and corporate treasurers are usually the main individuals responsible for overall cash management strategies, stability analysis, and other cash-related responsibilities. However, many organizations may outsource part or all of their cash management responsibilities to some service providers.

The cash flow statement is the main component of a company’s cash flow management. The cash flow statement comprehensively records all of the organization’s cash inflows and outflows. It includes cash from operating activities, cash paid for investing activities, and cash from financing activities. The bottom line of the cash flow statement shows how much cash is readily available for an organization.

The cash flow statement is divided into three parts: investing, financing, and operating activities. The operating part of cash activities is based heavily on the net working capital, which is presented on the cash flow statement as a company’s current assets minus current liabilities. Businesses strive to make the current assets balance exceed the current liabilities balance.

The other two parts of the cash flow statement are somewhat more straightforward with cash inflows and outflows connected to investing and financing, such as investments into real estate, buying new equipment and machinery, and originating stock repurchases, or paying out dividends as part of the financing activities.

There are many internal controls utilized to manage and achieve efficient business cash flows. Some of a business’s major cash flow considerations comprise the average length of account receivables, write-offs for uncollected receivables, collection processes, rates of return on cash equivalent investments, liquidity, and credit line management.

 

What Does Working Capital Include?

Generally, working capital includes the following:

 

1. Current assets

  • Cash
  • Accounts receivable within one year
  • Inventory

 

2. Current liabilities

  • Accounts payable due within a year
  • Short-term debt payments due within one year

 

On the cash flow statement, organizations usually report the change in working capital from one reporting period to the next in the operating section of the cash flow statement. If the net change in working capital is positive, an enterprise’s increased its current assets available to cover current liabilities.

If a net change in working capital is negative, an enterprise’s increased its current liabilities, which reduces its ability to pay the liabilities efficiently. A negative net change in working capital lowers the total cash on the bottom line as well.

 

Cash Management - Causes of Problems

 

Causes of Problems with Cash Management

Unfortunately, many businesses engage in poor cash management, and there are several reasons for the problem. Let us look at some of them:

 

1. Poor understanding of the cash flow cycle

Business management should clearly understand the timing of cash inflows and outflows from the entity, such as when to pay for accounts payable and purchase inventory. During rapid growth, a company can end up running out of money because of over-purchasing inventory, yet not receiving payment for it.

 

2. Lack of understanding of profit versus cash

A company can generate profits on its income statement and be burning cash on the cash flow statement.

When a company generates revenue, it does not necessarily mean it already received cash payment for that revenue. So, a very fast-growing business that requires a lot of inventory may be generating lots of revenue but not receiving positive cash flows on it.

 

3. Lack of cash management skills

It is crucial for managers to acquire the necessary skills despite the understanding of the abovementioned issues. The skills involve the ability to optimize and manage the working capital. It can include discipline and putting the proper frameworks in place to ensure the receivables are collected on time and that payables are not paid more quickly than is needed.

 

4. Bad capital investments

A company may allocate capital to projects that ultimately do not generate sufficient return on investment or sufficient cash flows to justify the investments. If such is the case, the investments will be a net drain on the cash flow statement, and eventually, on the company’s cash balance.

 

Related Readings

CFI is the official provider of the Certified Banking & Credit Analyst (CBCA)™ certification program, designed to transform anyone into a world-class financial analyst.

To keep learning and developing your knowledge of credit analysis, we highly recommend the additional resources below:

  • Cash Flow Statement
  • Current Liabilities
  • Inventory
  • Personal Finance

Financial Analyst Training

Get world-class financial training with CFI’s online certified financial analyst training program!

Gain the confidence you need to move up the ladder in a high powered corporate finance career path.

 

Learn financial modeling and valuation in Excel the easy way, with step-by-step training.