Cash Management
Cash is the most liquid asset owned by a business and plays a vital role in its day-to-day operations. A company’s cash account includes currency and coins on hand, bank deposits such as checking and savings accounts, and negotiable instruments that can be readily deposited in a bank. These instruments include customer cheques, cashier’s cheques, certified cheques, money orders, and similar items.
Cash is often referred to as the life-blood of a business because it is essential for meeting financial obligations and maintaining the firm’s solvency. For the purpose of cash management, the term cash also includes near-cash assets such as marketable securities and time deposits with banks, as they can be easily and quickly converted into cash.
Cash management is the process of planning, controlling, and monitoring cash flows to ensure adequate liquidity while minimizing idle cash. The objective is to strike a balance between maintaining sufficient cash for daily requirements and efficiently utilizing surplus funds.
For businesses, effective cash management ensures smooth operations, timely payments to suppliers and employees, and the ability to meet unexpected expenses. Individuals also practice cash management to meet personal expenses and earn returns through suitable financial instruments.
Cash management involves three major aspects:
- Management of cash inflows and outflows – accelerating cash receipts through efficient billing, prompt collections, and electronic payment systems, while controlling and properly timing cash payments.
- Management of cash flows within the firm – ensuring proper transfer and utilization of cash among different departments or units.
- Management of cash balances – maintaining an optimal level of cash by financing deficits when cash is insufficient and investing surplus cash profitably.
Thus, cash management focuses on maintaining liquidity, reducing unnecessary cash holdings, and ensuring that cash is available whenever needed to meet the firm’s obligations.
Objectives of Cash Management
The objectives of cash management are closely aligned with the twin goals of working capital management, namely liquidity and profitability. The primary responsibility of the cash manager is to ensure the availability of the right amount of cash at the right time for the right purpose.
Maintaining excessive cash balances does not improve efficiency, as idle cash earns no return and results in a loss of interest income. Such idle funds impose an opportunity cost, which adversely affects the profitability of the firm. On the other hand, inadequate cash may disrupt operations and harm the firm’s ability to meet its obligations.
Therefore, the key objective of cash management is to maintain an optimum level of cash neither excess nor shortage so that the firm can meet its payment requirements smoothly while minimizing the cost of holding cash and maximizing overall profitability.
Importance of Cash Management
Cash is a unique resource and is not comparable with any other component of current assets. While other assets such as inventory can generate value over time, cash by itself is non-productive. If excess cash is held, it does not generate profits, as cash is a sterile asset and does not directly contribute to earnings.
Unlike cash, excess inventory can still be useful in the future and, in many cases, may even increase in value due to inflation. Idle cash, however, results in a loss of interest income and imposes an opportunity cost on the firm.
On the other hand, a shortage of cash can cause serious and irreparable damage to the business. Inadequate cash may lead to missed profitable opportunities and failure to meet payment obligations on time. Such delays not only disrupt operations but also harm the firm’s reputation and goodwill in the market.
Therefore, effective cash management is essential to maintain an optimal cash balance, ensuring smooth business operations, protecting profitability, and preserving the firm’s credibility and long-term growth.
Cash Management Cycle
Cash management seeks to operate the cash cycle efficiently at the lowest cost, while simultaneously maintaining sufficient liquidity and exercising proper control over cash inflows, outflows, and balances.
Facets of Cash Management
While planning cash management, the twin objectives of liquidity and profitability must be carefully balanced. To achieve these objectives, management needs to formulate effective strategies across the following key facets of cash management:
- Cash Planning – Estimating future cash inflows and outflows to ensure the availability of funds when required.
- Investment of Surplus Cash – Productively investing excess cash in short-term, low-risk instruments to earn returns without compromising liquidity.
- Management of Cash Flows – Monitoring and controlling cash receipts and payments to maintain smooth business operations.
- Determination of Optimum Cash Level – Maintaining neither excess nor insufficient cash to minimize holding costs and avoid liquidity problems.
Effective management of these facets ensures efficient utilization of cash and supports the overall financial health of the firm.
Motives of Holding Cash
Firms hold cash to meet various needs, which are explained through the following motives:
- Transaction Motive Cash is held to meet routine business expenses and conduct day-to-day operations such as payment of wages, purchases, and other operating costs.
- Precautionary Motive Cash is maintained as a safeguard against unexpected events and uncertainties, such as delays in cash receipts, sudden expenses, or emergencies.
- Speculative Motive Cash is held to take advantage of profitable opportunities that may arise in the future, such as purchasing assets at favorable prices or investing in short-term gain opportunities.
These motives collectively explain the importance of maintaining adequate cash balances in a business.
Principles of Cash Management
The primary objective of cash management is to ensure adequate liquidity while minimizing the cost of holding cash. This objective can be achieved by following the key principles outlined below:
- Accelerating Cash Collections – Speeding up cash inflows through efficient billing, prompt collections, and electronic payment systems.
- Delaying Cash Payments – Strategically timing payments without damaging the firm’s creditworthiness.
- Investment of Surplus Cash – Investing excess cash in short-term, low-risk instruments to earn returns.
- Maintenance of Minimum Cash Balance – Holding only the necessary amount of cash to meet operational needs and contingencies.
Maintaining an Optimum Cash Balance
A firm should maintain an optimum cash balance, which is neither excessive nor insufficient. Excess cash leads to opportunity cost, while inadequate cash may disrupt operations and affect goodwill. To determine the optimum level of cash, the following two models are commonly discussed:
These models help management in deciding the appropriate cash balance by balancing liquidity requirements with profitability considerations.
0 Comments