Cash Management, the Key to Business Survival

 


  •  One of the miserable things in life is to have no money in your pocket.
  • You cannot go to your favorite restaurant, go to the mall, wear the best clothes, and go for sightseeing when the pocket is empty. This is true for businesses alike. Without cash, a firm would struggle to survive in business.
  • Cashflow is the lifeline of a business.

 Cash is used by individuals and companies to settle debt obligations and operating expenses. For example, a business needs cash to pay taxes, pay employee salaries, purchase inventory, pay for rent etc. Having seen the importance of cash to a business, it is necessary for firms to manage it properly.

 Cash is held for transactional, precautionary and speculative reasons. Transactional reasons refer to holding cash to meet payments in the ordinary course of business. Precautionary reasons refer to holding cash to meet unforeseen cash needs. Speculative reasons refer holding cash to take advantage of opportunities as and when they show up.

 Let look at a simple scenario. Let suppose a firm has inventory turnover of 100 days. Inventory turnover days refers to the number of days inventory are kept in the warehouse before being sold. The firm’s payable are due in the next 30 days. However, receivables are due in 60 days. The company will face a cash crunch because the funds are blocked in debtors and inventory, and the payables are due in a lesser period. To mitigate this problem, the company could negotiate payment extension with the creditors or speed up the collection of receivables. If the company is unable to do this, then it would need to fall on loan to make up for the shortfall.

The goal of every business is to make profit. However, it is important to understand the difference between cash and profit. Profit is made whenever the company’s income exceeds its expenses. Income includes cash sales and credit sales. In the same way, expenses include accrued expenses and paid expenses. Cash inflow occurs when there is cash sales and cash outflow occur when there is payment. This means that though credit sales are recorded as income, it doesn’t mean that cash has been received. For this reason, a company could make profit on its income statement but could be going to through cash crunch.

 The goal of cash management is to maintain adequate cash level to meet short term obligations at all times. Holding idle cash comes with opportunity cost. This is the return that the entity would have earned if the idle cash was invested. For this reason, idle cash should be invested in money market instrument to earn some returns. Efficient management of cash include speeding up cash receipt, slowing down cash payments with no default and investment of idle cash temporarily. The level of cash to maintain always depends on:

 l  The transactions balance required when cash management is efficient.

l  The compensating balance requirements of commercial bank with which the firm has deposit.

 

 

 

 


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