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 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.
Why is cash flow management important in terms of running a successful business? ›
Cash flow management means tracking the money coming into your business and monitoring it against outgoings such as bills, salaries and property costs. When done well, it gives you a complete picture of cost versus revenue and ensures you have enough funds to pay your bills whilst also making a profit.
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.
What is the impact of cash management on business profitability? ›
The findings of this study revealed that there is insignificant but positive correlation between profitability in the business and implementation of cash management practices. So, Implementation of cash management practices helps the business owner to improve their profitability.
Why is the cash management model important? ›
The model helps in determining the cash conversion size which means how much cash should be arranged by selling marketable securities in each transaction. This model assumes that cash can be arranged through selling marketable securities which the firms hold in the time of needs.
How does cash flow affect business success? ›
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 cash management in business? ›
Cash management is the process of managing cash inflows and outflows. This process is important for individuals and businesses because cash is the primary asset used to invest and pay any liabilities.
What are the positive effects of cash management? ›
Advantages of positive cash flow
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 is the impact of cash management? ›
Reducing borrowing costs through effective cash management can lower interest expenses, improve financial health and preserve credit ratings. It also provides businesses with increased flexibility, control, and profitability.
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.
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.
How to improve cash flow in a business? ›
6 ways to improve cash flow in your business
- Use software to track your inflows and outflows. ...
- Send invoices out immediately. ...
- Offer various payment options for customers. ...
- Reduce operating costs. ...
- Encourage early payments, while discouraging late payments. ...
- Experiment with your prices.
Cash flow management helps small businesses avoid cash shortages by ensuring that they have enough cash on hand to cover their expenses. By tracking cash inflows and outflows, businesses can identify periods of low cash flow and take steps to reduce expenses or increase revenue.
What is the relationship between cash flow management and profitability? ›
There is a close relationship between cash flow and profitability. A business with a positive cash flow is more likely to be profitable than a business with a negative cash flow. However, it is important to understand that a business can be profitable without having a positive cash flow.
What are the three factors that can affect your cash flow and business profitability? ›
Here are six crucial factors that affect your business' cash flow:
- Receivables Management. Accounts receivable is the balance of money owed to a company after rendering products and services. ...
- Investing and Financing. ...
- Employee Management. ...
- Market Environment. ...
- Payment Management. ...
- Working Capital Acquisition.
In this example, cash flow is more important because it keeps the business running while still maintaining a profit. Alternately, a business may see increased revenue and cash flow, but there is a substantial amount of debt, so the business does not make a profit.
