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Cash Management 101

Written By: Leslie Satenstein
Published On: August 13 2008

Cash management is a need common to both large and small businesses alike. In its simplest terms, cash management is the assurance that today's receivables plus today's account balances exceed today's payables. Failure to practice this business management process guarantees bankruptcy.

Every large organization has a cash management group, sometimes called the treasury. This group's function includes management of such items as investments and borrowing in addition to the organization's daily cash flow. In small to medium businesses (SMBs), usually the chief financial officer (CFO), president, or owner performs the task of cash management.

Regardless of a company's size, the important thing is that cash management is practiced on a regular basis—at least weekly—and with sufficient attention to details. In difficult times, when liquidity is "tight" (at a minimum), it should be performed daily.

Crucial to organizations' successful cash management are the deals they make with their financial institutions for short-term placements and for borrowing funds. Unlike in other countries, in the United States, a bank account that is credited with deposits does not begin to earn deposit interest until three business days have passed. Furthermore, an American business account specifically may not be overdrawn, which necessitates cash management to be the most important activity of a business's financial management.

For all companies—and in particular, public traded companies—major financial statements include the income statement, the balance sheet, and the statement of cash flows. An organization's CFO, accountant, or proprietor will likely share this snapshot of financial performance with lenders, equity investors, and the company directors and key stakeholders.

Surprisingly, most SMBs and large organizations find spreadsheets a useful tool for cash management. The cash management facilities serve as the basis for entries on the spreadsheet. The spreadsheet is easy to manipulate and allows for what-if scenarios and forecasting. Yet cash management for many companies is a mix of financial software and spreadsheets, with the majority of decisions based on spreadsheet manipulations.

Cash Management Operations

Effective cash management requires having a firm handle on the following two areas:

1. Cash inflows

  • Daily morning and afternoon deposits from the Automated Clearing House (ACH)—where morning deposits are received from local banks and afternoon deposits are received from banks located more than two time zones away—electronic data interchange (EDI) transfers, e-mail notifications, etc.

  • Forecasted deposits for the day, generated from cash management software. These are based on reliable deposits taken from sales invoice dates plus credit days allowed (e.g., net 30, 2 percent net 10, etc.).

  • Checks received in the mail.

  • Over-the-counter cash receipts.

  • Credit card receipts.

  • Forecasted deposits based on disputed invoices (i.e., invoices where credit notes may have to be issued) or the "poor payer" category of customers, generated from cash management software.

  • Investment income.

2. Cash outflows

  • "Must pay" accounts (e.g., payroll).

  • Commissions; local, state, and federal liabilities (e.g., taxes, social security, etc).

  • Payment to liability accounts (e.g., insurance, mortgages, leases, employee travel expenses).

  • Valuable suppliers that provide payment discounts for early payment.

  • Suppliers whose limits within agreements can be stretched (e.g., net 30 days).

  • All bank account balances.

  • Loan payments due.

  • Interest payments or term deposits due.

The Price of Cash Mismanagement

When cash flow is tight, cash management helps a company decide who must be paid and whose payment can be skipped for a given week. Mismanagement of cash inflows and outflows will cause a company to face a liquidity crunch. A liquidity crunch forces a company to borrow money at a disadvantage, meaning a company that is in dire need of short-term cash will pay more interest on a loan or line of credit than it would have had it used better cash management techniques.

Poor decisions and practices by a company's financial managers can have disastrous effects on the business too. Following are examples of poor decisions and practices:

  • Transferring too much of the business's liquid assets into the acquisition of fixed assets, such as machinery or real estate. Monthly commit¬ments must be properly managed by obtaining long-term financing for such large capital investments.

  • Failing to budget properly. To avoid this problem, construct a spreadsheet with columns that represent weeks or months, and with rows that represent inflows or outflows. Lay out, by month, the known inflows and outflows. Toward the bottom of the sheet, place the less-certain inflows and outflows. Each period's column total (closing balance) should be brought forward to the next column as an opening balance.

  • Failing to make use of a business line of credit (LOC), or exceeding the LOC limit, resulting in refinancing with factorers. Factorers are organizations that provide funds to a business, using the business's inventory as collateral. A factorer can be a vendor's representative as well, selling on commission. Factorers can also provide cash based on a business's future confirmed receivables. Their rates for lending money are usually higher than bank rates.

  • Failing to manage business risks (e.g., making poor client choices, overextending credit to poor payers, under or overestimating product sales, etc.).

  • Failing to keep personal money out of the company. It is essential to separate personal and business dealings. Obtain business credit cards and keep detailed track of business expenditures for shared assets (e.g., vehicles, travel, entertainment, etc.).

  • Failing to go after nonpayment or late payment accounts.

  • Failing to pay attention to inventory or inventory turns. Inventory turns is a measure of the number of times inventory, save for safety stock, is sold. In general, the more the number of turns, the lower the cost of warehousing and insuring stock, as well as in tying up capital.

  • In cash shortage periods, failing to defer some invoices for payment in a later financial period. (Become a 90-day payer with some suppliers, but it is not recommended to do this with the same supplier over and over again.)

The Web is a direct vehicle to a wealth of information on cash management. One highly recommended source is the Internet-based tutorial from the Hancock Bank: Cash Flow Management. Another is an article from the Business Development Bank of Canada: Techniques for Better Cash Flow Management. The Treasury Management Association of Canada (TMAC) offers onsite and Internet-based full-day training courses on cash management. Its web page contains the topics covered in the course and bullets the areas you should follow as standard cash management business practices.

A Helpful Tool: Enterprise Resource Planning (ERP)–based Cash Management

Every ERP system offers some elementary accounting functions. To get started in cash management, a few basic sets of reports that every ERP and accounting system provides include the following: open sales orders, aged analysis, open and closed purchase orders, shipping reports, inventory evaluations, fixed assets, and general ledger statements.

Bring this information together with other financial information to the ubiquitous spreadsheet program. Produce a cash-flow analysis schedule. Look at all areas of your business practices and get a good feel for where to make improvements. Go after areas that will yield the most results from being improved. Find out how much businesses similar to yours spend in these areas. Ask your accountancy firm for advice. Look at business process optimization to determine if there is too much paper-handling and if there are inefficient workflow processes.

Cash management is an analytical process performed by humans, using industry knowledge, gut feelings, and knowledge of the levels of risk. Computer applications that feed business decisions do not think and do not have knowledge. Rather, they apply the kind of logic needed, for example, to compare .001 to .0001. They cannot do what the human brain can do, and that is think. Humans make the final business decisions, not machines.

Some ERP applications have better financial capabilities than others; they have financials which include analytical applications that go beyond the simple accounts receivable (A/R) and accounts payable (A/P) tools. They perform the intelligent, automated merging of the items listed above. They also allow the following items to be entered, to create a big picture of an organization's situation:

  • a cash balance report, which shows bank balances, incoming and outgoing cash, and dollar fluctuations

  • bank web sites, to spot-check morning or afternoon incoming cash status before authorizing purchase invoice payments

  • a cash diary, to identify cash inflows and outflows by absolute certainty transactions (e.g., investments, expenses)

  • payroll reports

  • business intelligence (BI) triggers and alerts

  • ACH receipts and bank files

  • budgets

Some vendors to consider for an ERP application to help you handle your cash management processes include Agresso, Flexi, SAP, and Lawson. These vendors are known for their focus on financial ERP systems and cash management. You can learn about more vendors and their offerings here.

Conclusion

Cash management is crucial for the survival of any organization. Realize that purchasing an ERP system that includes a specialized cash management module does not mean you can become lax with your cash management practices; you will still need to pay close attention to the critical areas discussed in this article.

Learn your business, learn your market, and learn as much as you can about your suppliers, competitors, and clients. Couple this information with effective cash management, and you'll be well positioned to grow your business—not close it.

 
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