Cash Management: A Comprehensive Guide to Financial Stability

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 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 billsTreasury Bills (T-Bills)Treasury Bills (or T-Bills for short) are a short-term financial instrument issued by the US Treasury with maturity periods from a few days up to 52 weeks., 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.

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)PP&E (Property, Plant and Equipment)PP&E (Property, Plant, and Equipment) is one of the core non-current assets found on the balance sheet. PP&E is impacted by Capex, 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 statementCash Flow Statement​A cash flow Statement contains information on how much cash a company generated and used during a given period. 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 capitalNet Working CapitalNet Working Capital (NWC) is the difference between a company's current assets (net of cash) and current liabilities (net of debt) on its balance sheet., 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 receivablesAccounts ReceivableAccounts Receivable (AR) represents the credit sales of a business, which have not yet been collected from its customers. Companies allow, 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.

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 Commercial Banking & Credit Analyst (CBCA)™Program Page - CBCAGet CFI's CBCA™ certification and become a Commercial Banking & Credit Analyst. Enroll and advance your career with our certification programs and courses. 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 StatementCash Flow Statement​A cash flow Statement contains information on how much cash a company generated and used during a given period.
• Current LiabilitiesCurrent LiabilitiesCurrent liabilities are financial obligations of a business entity that are due and payable within a year. A company shows these on the
• InventoryInventoryInventory is a current asset account found on the balance sheet, consisting of all raw materials, work-in-progress, and finished goods that a
• Personal FinancePersonal FinancePersonal finance is the process of planning and managing personal financial activities such as income generation, spending, saving, investing, and protection. The process of managing one’s personal finances can be summarized in a budget or financial plan.