Cash Management

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What is Cash Management?

Cash Management refers to the collection, handling, control and investment of the organizational cash and cash equivalents, to ensure optimum utilization of the firm’s liquid resources.

Objectives of Cash Management

After getting familiar with the motives behind holding the cash balance, we should know the objectives that govern the process of cash management. The cash management is done with two basic objectives:

  • To meet the payment schedule
  • To minimize Funds as cash balance.

To meet payment Schedule

The firms are required to make regular payments in regular course of business to suppliers of goods, employees, for expenses, etc. Simultaneously, there are cash inflows also in form of collections from customers.

Cash management serves the objective of making cash available to meet the payment schedule in case the inflows are less than the outflows. So, the firm keeps adequate cash balances to fulfill the objectives.

Thus, the maintenance of adequate cash balance to meet the payment schedule is important for following reasons:

  • Avoids bankruptcy that may arise due to inability of the firm to meet its obligations.
  • The relations with the suppliers, creditors and the bank are not strained and there repayments are made timely.
  • The firm can avail Cash discounts by making the payments within the due dates.
  • Provides strong credit rating to the firm enabling to get favorable terms in credit transactions in purchase of goods and bank loans.
  • The firm is in the position to meet the contingencies and unexpected cash expenditures easily.
  • Firms can take advantages of opportunities that may be available.

To minimize fund committed as Cash Balance

The other core objective of cash management is to minimize the cash balances. Since, it is clear that cash when held as asset do not earn any returns, it is important for the firm to maintain the cash balances which reduces over investment of funds in cash balance while fulfilling the transaction needs as discussed above.

While the high cash balance ensures prompt payment and increases credibility of the firm, the large funds kept as cash balance results in idle funds and the firm will have to forego profits.

A very low level of cash may on the other side lead to failure to meet the payments schedule. Thus, the objective of cash management is to have an optimal cash balance.


Cash Management Strategies

The cash management strategies aims at minimizing the operating cash balance requirements of the firm. Thus the strategies help in reducing the cash cycle and increasing the cash turnover.

The basic four strategies that can be employed for cash management are:

  • Stretching accounts payables
    This process follows the simple strategy of delaying the payment for accounts payables. Thus the firm must try to delay the payment of accounts payables as late as possible without affecting the credibility of the firm.

    However, in case there are cash discounts available on prompt payment, the firm must not hesitate to take advantage of these.


  • Efficient Inventory- Production Management
    Cash is blocked in high level of inventory. Thus another method of reducing the cash investment is managing the inventory. This can be done by increasing the inventory turnover, reducing the production cycle and by increasing the finished goods turnover.

    All these activities require better production planning and forecasting of the sales of the products.


  • Speeding collection of Accounts Receivables
    The other strategy for cash management is the management of accounts receivables. The firm should try to collect accounts receivables as quickly as possible. However, this should not be done at the cost of loss of future sales or loss of customers.

    The credit period can be reduced by changing the credit terms, credit standards and collections policies. The credit standards lay down the criteria that determine the customers who should be allowed the credit.


  • Combined cash management policies
    Instead of using the above strategies independently, the firm can use the combination of these strategies to get the maximum benefit. Thus the firm must see that there should not be too much delay in payment of accounts payables so that the credit standing is maintained and the purchases are done at desirable prices.

    The inventory must not be too low to result in stock out and the credit policy must not be too strict to keep away the customers and affect the sales negatively. The combined strategies, requires liquidity management, working capital management, risk management and financial management simultaneously by the company.

Cash Management Techniques

Some techniques that can be used to implement the cash managements strategies discussed above are follows:

Collect Quickly

The best form of cash management is to collect payments as quickly as possible. Making sure that all payments are processed on time and that customers with credit get their invoices well ahead of the bill due date is always a good idea.

Don’t wait until the end of the month to send out invoices; it is a fact that the longer you go without contacting a customer, the less chance you have of collecting the debt. The only way to maintain your working capital is make sure the cash flow is steady and on time.

Monitoring Costs and Inventory

Keeping an eye on how much you are paying to suppliers should be at the front of your business mind at all times. It doesn’t hurt to shop around for a better deal; even if you can’t get a better price than your current supplier, maybe you can get more agreeable payment options that leave you with more cash in hand at the end of every month.

Also monitory your inventory closely; paying attention to what is selling and what is not. Try to keep your inventory as lean as possible so you aren’t tying up too much of your working capital.

Concentration Banking

The system involves decentralized collection of accounts receivables by the firm which have large number of branches at different locations. Concentration Banking is system whereby customers make payments to a regional collection center which transfers the funds to at the principal bank.

An example of a concentration bank can be a company which has multiple chain stores across the country and each store deposits its cash into local banks. The company can set it up so that these funds can be concentrated or deposited into one account, usually called a concentration account, at a concentration bank. The concentration banking results in saving of time of collection, and hence results in better cash management.

However, the selection of collection centers must be based on the volume of billing/business in a particular geographical area. It may be noted that the concentration banking also involve a cost in terms of minimum cash balance required with a bank or in the form of normal minimum cost of maintaining a current account.

Lockbox System

This technique involves setting up post office lock Box at important collection centers and helps speed up posting of customers’ payments to your bank account. Payments are mailed to a P.O. Box directly accessible by the bank, which processes receipts daily. Thus one doesn’t have to go to the bank (or send a subordinate) and stand in line to make deposits.

Deposited checks don’t sit in a teller’s drawer all day; they are taken directly to the processing department. If your bank is regional or national you can set up lock-box accounts near your biggest customers, eliminating days of postal travel time for checks they mail to you.

Float

The cash balance shown in the company’s Ledger may not be the same as the available balance in its bank account. The difference is the net float. When the firm has written large number of cheques awaiting clearance, the available balance will be larger than the ledger balance.

When the firm has just deposited large number of Cheques, which have not been collected by the bank, the available balance will be smaller. The amount of Cheque issued but not presented for payment is known as the disbursement float.

For example, suppose that ABC Company has a book balance as well as an available balance of Rs 4 Lac with its bank, State Bank of India, as on March 31. On April 1 it pays Rs 1 Lac by Cheque to one of its suppliers and hence reduces its book balance by Rs. 1 Lac. The amount of Cheque deposited in the banks, but not yet cleared, is known as the collection float.

Electronic Data Interchange (EDI)

It refers to direct, electronic exchange of information between various parties. Financial EDI or FEDI, involves electronic transfer of information and funds between transacting parties. FEDI leads to elimination of paper invoices, paper cheques, mailing handling and so on.

Under FEDI, the seller sends the bill electronically to the buyer, the buyer electronically authorizes its bank to make a payment, and the bank transfers funds electronically to the account of the seller at a designed bank. The net effect is that the time required to complete a business transaction is shortened considerably thereby virtually eliminating the float.

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