Definition of Cash Management
Cash management is also known as treasury management, refers to the process of collection, management, and usage of cash flows for the purpose of maintaining a decent level of liquidity, and it involves financial instruments such as treasury bills, certificate of deposit, and money market funds making the same substance for not just individuals but organizations too.
Explanation:
It is a process in which the cash is collected, disbursed, and invested so that there is maximum liquidity. It also helps in maximizing profitability by optimizing cash utilization. It also helps in creating provisions for future contingencies such as economic slowdown, bad debts, etc.
Types of Cash Management
Following are the types given below:
- Cash Flow from Operating Activities: It is found on an organisation’s cash flow statement, and it does not include cash flow from investing.
- Free Cash Flow to Equity: Free Cash Flow to Equity represents the amount of cash that is available after the capital is reinvested.
- Free Cash Flow to The Firm: It is used for the purpose of valuation and financial modeling.
- The Net Change in Cash: It refers to the movement in the total amount of cash flow from a particular accounting period to another.
Roles and Functions of Cash Management
The roles and functions are explained below-
1. Inventory Management
Cash management helps an organization in managing its inventories. Higher inventory in hand indicates trapped sales, and this further leads to less liquidity. Therefore, a company must always focus on fast pacing its stock out for allowing the movement of cash.
2. Receivables Management
A company focuses on raising its invoices so that sales can be boosted. The credit period with respect to receiving cash might range between a minimum of 30 and a maximum of 90 days. This means that the organization has recorded all its sales, but the cash with respect to these transactions has not yet been received.
In such a scenario, cash management’s function will ensure that there is a faster recovery of all the receivables to avoid a probable cash crunch. It also includes a follow-up mechanism that ensures there is faster recovery and will also make the company aware of future contingencies like bad debts, etc.
3. Payables Management
This is also an important function of cash management where the companies can avail benefits like cash discounts and credit period.
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Objectives of Cash Management
The objectives of cash management include fulfilling working capital requirements, handling unorganized costs, planning capital expenditure, appropriate utilization of funds, planning capital expenditure, initiating investments, etc. The other objectives of cash management are maximizing liquidity, regulation of cash flows, maximizing the value of available funds, and lowering the costs pertaining to funds.
Basic Principles of Cash Management
Below are the different principles:
1. Maintaining lower inventory levels: Keeping a larger inventory level can often lead to a scenario where cash gets unnecessarily stuck. Even the warehouse space gets occupied unnecessarily. Companies must come up with appropriate techniques and strategies to be able to maintain lower levels of inventory successfully.
2. Speeding up the process of cash receivables: The companies must encourage their clients and customers to pay their dues quicker, and they must offer them lucrative discounts and such other schemes that motivate them to pay as early as possible.
Example of Cash Management
Following is ABC’s weekly average cash balances:
Total: $46,000
Annual interest rate= 12%
Monthly Average Cash Balance is calculated as
- Monthly Average Cash Balance= $46,000 / 4
- Monthly average cash balance = $11,500
Monthly Return on Average Cash Balance is calculated as
- Monthly Return on Average Cash Balance = $11,500 * 0.1
- Monthly Return on Average Cash Balance = $115
Using this, the company will manage the cash of its business.
Cash Management Strategies
The strategies pertaining to cash management are:
- One must always ask for a milestone or deposit payment
- The customers must be encouraged to clear their bills faster
- One must always make sure that the expenses are always bare minimum or even delayed.
- One must request the vendors to modify their payment terms
- Finance and fulfill purchase orders
- Idle equipment must be put for sale or on lease
- Boost profit margins
- Invoice factoring/ invoice discounting/ invoice financing/ sale invoices.
Different Types of Cash Management Tools
Following are the different types as given below:
- Short term instruments such as Money Market instruments and mutual funds, Treasury Bills, Certificate of deposit (CD), etc.
- Checking account
- Savings account
- Long term low-risk savings instrument
Limitations of Cash Management
The limitations are as follows:
- Cash management ignores the accrual concept of accounting
- It is historical in nature; that is; it rearranges the current information which is provided in the profit and loss statement and the balance sheet.
- It is not a substitute for a profit and loss statement.
- It ignores non-cash transactions.
Advantages and Disadvantages
Following are the advantages and disadvantages as given below:
Advantages
The advantages listed below are as follows
- Cash management allows estimating the cash profits and not just profits from outstanding incomes and credit sales.
- It helps in detecting cash embezzlement.
- It allows in speeding up the working capital cycle.
- It helps in rewarding such debtors that make quicker payments.
- It speeds up the operations of an organization.
Disadvantages
The disadvantages listed below are as follows.
- Management of the cash requires the specified skills of the person managing it.
- It is a time-consuming process.
Conclusion
It is also better known as treasury management. A treasurer of an organization looks after the overall cash management for the same. It helps in estimating the cash profits instead of profits earned through credit sales. It can also help in tracing cash embezzlement.
It solves all the problems pertaining to the deficiency in working capital. It also ensures that a company’s solvency is not impacted and the current value of money is more effectively taken into use, along with speeding up the company’s operational activities. However, it must be noted that it is not a substitute for profit and loss statements.
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