Cash management is the practice of managing a company’s financial assets to maximize liquidity while minimizing costs and risk. It involves collecting revenues, managing payments, and maintaining any surplus funds. Businesses use cash management to improve their solvency and overall financial stability, to ensure they have enough cash flow to meet their immediate and short-term obligations, and to secure the best returns on any idle cash.

Cash management involves understanding market trends, forecasting financial needs, and preparing for potential economic shifts. It helps a company sustain operations even in unpredictable times and strategically position itself for future growth. Effective cash management might also entail choosing the right mix of investments, fine-tuning payment terms, and using financial instruments in line with the company’s liquidity needs and risk tolerance. This requires a nuanced understanding of both the internal dynamics of the company and the external economic environment in which it operates.

Below, we’ll cover how cash management works, why it’s important, potential challenges to consider, and ways to improve your company’s cash management.

What’s in this article?

• How does cash management work?
  
• Why is cash management important?
  
• What is in a cash flow statement?
  
• Examples of cash management
  
• Cash management strategies for online businesses
  
• What are the challenges of cash management?
  
• How to improve your cash management
  

How does cash management work?

Cash management is the practice of monitoring, analyzing, and refining the flow of cash in and out of a business. Here’s how it typically works:

• Cash collection: Get cash into the business as quickly as possible. Tactics include simplifying the process of receiving payments from customers with faster invoicing, offering multiple payment methods, and using electronic payment systems to speed up transaction times.

• Cash disbursement: Manage the outflow of cash to meet business obligations without holding too much idle cash. This can involve scheduling payments to take advantage of creditor terms or using precisely timed electronic payment methods.

• Cash forecasting: Predict future cash flow to help show when cash might be tight and when there might be a surplus. This involves analyzing cash flow patterns over time and considering future plans and market conditions.

• Investment management: Use any surplus cash. This can include investing excess cash in short-term, low-risk instruments like treasury bills or money market funds, which provide a return but can be quickly liquidated if cash is needed.

• Bank relationship management: Maintain good relationships with banks to negotiate better terms for fees, gain access to better investment products, and ensure that the business has access to additional funds through lines of credit, if needed.

Why is cash management important?

Cash management is a strategic practice that impacts a company’s ability to operate effectively, invest wisely, and grow sustainably. Companies in every industry can experience cash flow problems. Here’s how proper cash management can help a business:

• Maintaining liquidity: Cash management ensures a business always has enough liquid resources to meet its immediate and short-term obligations, such as paying employees, suppliers, and creditors on time. Effective cash management allows a business to operate without unexpected cash shortages, which could damage its reputation or cause disruptions.

• Financial stability and solvency: Good cash management practices help a company maintain financial stability during downturns or when unexpected expenses arise. This allows the business to remain solvent and continue operating without the need for expensive emergency funding.

• Cost reduction: A strong strategy for managing cash helps businesses minimize the costs of borrowing. Knowing when cash will be available can reduce the need to draw on lines of credit or take out loans.

• Maximize profits: With effective cash management, companies can maximize their profits by investing surplus cash to yield returns without compromising liquidity. This can improve a company’s earnings from interest or other investment income.

• Risk management: Cash management safeguards against financial risks such as currency fluctuations, interest rate volatility, and changes in market conditions. By maintaining an optimal level of cash, a business can insulate itself from these risks and more readily adapt to counter financial pressures.

• Strategic planning and growth: Effective cash management facilitates more accurate financial forecasting and budgeting, which are necessary for strategic planning. Understanding cash flow patterns helps businesses sustainably plan for growth and expansion.

What is in a cash flow statement?

A cash flow statement is a financial document that provides detailed information about a company’s cash inflows and outflows over a specific period. Here are the three main sections on this kind of statement.

Operating activities

• Cash receipts from customers: Money received from sales of goods or services

• Cash payments to suppliers and employees: Money paid out for operating expenses, including wages and inventory

• Interest paid and received: Cash paid for interest on loans and received from investments

• Taxes paid: Money paid for corporate income taxes

• Other operating cash flows: Miscellaneous cash transactions related to core business operations

Investing activities

• Purchase of equipment and assets: Cash spent on acquiring long-term assets such as machinery, buildings, and land

• Sale of equipment and assets: Cash received from selling long-term assets

• Purchase and sale of investments: Cash spent on or received from buying or selling investment securities

• Loans made and collected: Cash outflows for loans given to others and inflows from loan repayments

Financing activities

• Issuance of stocks and bonds: Cash inflows from issuing shares or bonds

• Repayment of debt: Cash outflows for repaying borrowed funds

• Dividends paid: Money paid to shareholders as dividends

• Other financing cash flows: Cash transactions related to the company’s financing structure, such as obtaining and repaying a mortgage

Examples of cash management

Here are some real-world examples of cash management strategies in action across five different industries.

Example 1: Retail

A retail company implements a cash management system that automates the reconciliation of daily sales data with bank deposits. This ensures all sales are promptly accounted for and deposited and reduces the risk of errors and delays in cash flow. The company also negotiates early payment discounts with its suppliers, which allows it to save on procurement costs and improve its working capital position.

Example 2: Manufacturing

A manufacturing company uses cash flow forecasting to anticipate periods of high demand for its products. By accurately predicting when it will need to purchase raw materials and pay for labor, the company can secure financing in advance. This keeps operations running and avoids costly production delays due to cash shortages.

Example 3: Professional services

A professional services firm offers clients discounts to incentivize early invoice payment. This encourages swift payment, accelerates cash inflows, and improves the firm’s cash flow. The firm closely monitors its accounts receivable, follows up on overdue invoices, and implements collections procedures, if necessary.

Example 4: Technology

A technology startup invests its surplus cash in a diversified portfolio of short-term, low-risk securities. This allows the company to earn interest on its idle cash while maintaining liquidity and funds for future growth initiatives.

Example 5: Nonprofits

A nonprofit organization receives a large donation from a philanthropist and works with a financial adviser to invest a portion of the donation in a long-term endowment fund. This generates a steady income stream to support the organization’s mission while preserving the principal for future generations.

Cash management strategies for online businesses

Here are some practical examples of cash management practices that online companies use to maintain a healthy cash flow:

• Invoicing and collection: A business can implement policies to promptly invoice customers and follow up on overdue accounts receivable. Electronic invoicing systems can speed up the billing process by setting clear payment terms or offering early payment discounts to encourage swift payments.

• Expense management: Companies often regularly review their expenses to find areas where they can cut costs without compromising quality or operations. This might involve negotiating better terms with suppliers, switching to more cost-effective vendors, or implementing energy-saving measures to reduce utility bills.

• Cash flow forecasting: By predicting future cash needs and potential shortfalls, a business can plan ahead. For instance, a retailer might analyze historical sales data to predict seasonal demand and adjust inventory purchases accordingly to avoid tying up too much cash in stock.

• Short-term investments: Businesses often park surplus cash in short-term, liquid investments such as treasury bills, money market funds, and high-yield savings accounts. This practice allows businesses to earn returns on the money while keeping it accessible, if needed.

• Technology: Many companies use cash management software to track and manage their cash flows in real time. This software can provide insight into cash positions, automate routine transactions, and help you make informed decisions about cash usage.

• Contingency planning: Establishing a line of credit or maintaining a reserve fund can provide a safety net for unexpected expenses or periods of low cash flow. This allows businesses to continue operating smoothly even during financial instability.

• Payroll management: Staggering payroll dates to align with cash inflows can help a company better manage its cash. For instance, the company might schedule payroll after the main monthly revenue inflows.

What are the challenges of cash management?

Cash management can present its own challenges, including unpredictability and low visibility. Here’s a closer look:

• Unpredictable cash flow: A sudden drop in sales due to economic downturns, a delay in a major project, or even a client’s financial difficulties can leave you scrambling to cover expenses. This unpredictability makes forecasting a challenge and can throw even the most careful plans off course.

• Late payments: Chasing late payments takes time and resources for reminders, follow-up, and potentially even legal action. Late payments can delay your own payments to suppliers and vendors, damage your credit rating, and impact your growth.

• Unexpected expenses: Unforeseen events can quickly drain your cash reserves and force you to look at financing options, which might not always be readily available or affordable. Even the most well-run businesses can face issues like equipment failures, sudden employee departures, or even natural disasters.

• Overspending: Overspending on marketing campaigns, new hires, or office space can quickly deplete your cash flow, especially if your revenue growth doesn’t keep pace. It’s important to maintain financial discipline and prioritize spending that directly contributes to your bottom line.

• Poor financial visibility: It’s difficult to manage cash flow without accurate, up-to-date financial information about your current cash position, upcoming payments, and outstanding invoices. Poor financial visibility can affect informed decisions about spending, investments, and day-to-day operations.

• Fraud and theft: Businesses are vulnerable to fraud and theft, both internally and externally. Employee embezzlement, vendor fraud, and cyberattacks can all cause major cash losses. Businesses can protect themselves with strong internal controls, regular audits, and cybersecurity measures.

• Regulatory changes: Changes in tax laws, industry regulations, or broader economic policy can also impact cash flow. Staying aware of these changes and adapting your cash management strategies accordingly helps avoid unexpected financial surprises.

How to improve your cash management

Improving cash management is an ongoing process that requires attention to detail and strategic planning. Here are some effective ways to keep your cash flow in a favorable position.

Refine accounts receivable

• Incentivize customers to pay sooner by offering a small discount for early payments.

• Implement automatic payment reminders to gently nudge clients who might have overlooked your invoices.

• Send invoices promptly.

• If you need immediate cash, sell your invoices to a factoring company at a discount.

Manage accounts payable

• Negotiate longer payment terms with your suppliers.

• Take advantage of any early-payment discounts from suppliers if you have the cash on hand.

• Strategically prioritize bill payment to avoid late fees and maintain good relationships with vendors.

Forecast cash flow

• Project your expected cash inflows and outflows for the coming weeks or months.

• Keep a close eye on your actual cash flow and compare it to your prediction.

• Adjust your spending or explore financing options if you foresee a cash shortage.

Reduce expenses

• Find areas where you can cut back or negotiate better deals.

• Identify any unnecessary subscriptions, services, or expenditures that you can cut.

• Compare prices for supplies, services, and other recurring expenses.

Build a cash reserve

• Try building a cash cushion equal to three to six months of operating expenses to help you weather unexpected events.

• Make saving a habit by automating transfers to your reserve account.

Use technology

• Simplify bookkeeping, invoicing, and financial reporting with accounting software.

• Use cash flow forecasting tools to better understand your future cash position.

• Use payment platforms to make it easy for customers to pay you online.