How To Do Cash Management (Components, Tips And Benefits)

Updated 12 November 2022

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Cash management is an important activity in operating a business. This process includes handling the cash flow to help a company grow and maintain financial security. Understanding the best financial management techniques can help you learn how an organisation operates. In this article, we learn about cash management and discuss how to implement monetary regulation effectively.

What Is Cash Management?

Cash management, also known as cash flow management, is a concept which involves handling a business's financial activities, such as operations, collections and investments. It is a crucial component of an organisation's financial calculations and contributes to its financial stability. Managing the cash flow can help develop and sustain a company and also support it in making calculated financial decisions. The four primary functions of cash flow management are:

Reducing the amount of excess cash in hand
Utilising cash effectively
Maintaining a balance to ensure the stability of a business in planned and unplanned situations
Managing the cash flow by handling the spending and tracking receipts regularly

Understanding The Components Of A Cash Flow Statement

A cash flow statement is an integral part of a company's financial management. Its purpose is to show the transfer of funds entering and leaving a company's bank accounts. This statement contains three major parts:

Operations

The operations segment of the statement may include the revenue generated from a business's major activities. It is known as cash flow from operating activities, or CFO. For example, an organisation's running costs, which include salary payments, buying inventory or equipment and the sales of products, come under the operations branch of a cash flow statement.

Finance activities

Cash flow from finance activities, or CFF, includes the cash generated from investors and shareholders in a business. For example, funds received from a company's investors belong to the financing part of the statement. The funds required to keep a business functional and the cash movement between investors and the organisation make up the CFF section of a cash flow statement.

Investments

The investment component of the statement, also known as cash flow from investing, or CFI, primarily relates to investments made by an organisation. This section comprises cash moving in and out of a business because of the sale and purchase of various assets, such as new equipment, land and securities. It can also include loans given to suppliers and revenue generated through company acquisitions.

Objectives Of Financial Management

Effective financial management may help businesses use their assets to their maximum potential and give organisations a clear view of their ability to reach their goals. The process enables a company to achieve two primary objectives:

Meeting payment schedules

It is necessary for a business to make payments regularly to ensure the organisation and its vendors and employees can function with minimal complaints. For example, a company may pay employees salaries and other expenses. While these are business expenses, there is also an inflow of cash from customers who buy the products. Imagine a situation where the amount of money flowing into a business is less than the cash flowing out. In this scenario, cash flow management can help companies to prepare for the availability of funds to meet payment schedules.

Companies can achieve this by maintaining a sufficient cash balance, which helps prevent complications arising from a business's inability to make timely payments. A business can maintain good relations with its creditors and suppliers by paying them promptly. Such payment obedience can also benefit a company through cash discounts, and it increases the business's credit rating, which can help when making purchases on credit or obtaining a bank loan. A company may make better business decisions by having accurate data about the financial resources at its disposal.

Minimising cash balance

Another essential objective is reducing a business's cash balance to maximise returns on the idle cash in its account. Since this money does not yield any returns, cash flow management can help a business invest such funds while maintaining enough cash to fulfil its scheduled payments. For example, a business with large sums of liquid assets may be able to pay its employees and suppliers on time. In contrast, a company with a small cash balance may struggle to meet the payment schedules.

How To Implement Cash Flow Management?

Depending on a company's financial strategy, it may implement different cash flow management techniques. These may aid businesses in increasing their cash turnover while decreasing their cash cycle. Here are the steps to implement cash flow management:

1. Manage production and inventory efficiently

Production of goods and inventory acquisition are the two highly cash-demanding processes in a business. A sizeable sum of cash gets locked when a company procures multiple categories of inventory. Businesses can implement cash flow management effectively by increasing the rate of acquiring and selling inventory and reducing the time taken to produce goods. They can perform efficiently by thoroughly planning the production cycle and predicting inventory sales.

2. Delay the payments for various accounts

Businesses can execute this cash flow management strategy by simply delaying the payments for various accounts without damaging the company's credibility. By so doing, a business may be able to sell existing inventory and still maintain an adequate cash balance for the account payables. Some vendors offer discounts available only for prompt payments, allowing companies to modify their cash flow management strategy.

3. Speed up the collection of receivables

Financial strategists can manage cash flow efficiently by carefully controlling the funds a business generates. A company may emphasise collecting the accounts receivables as soon as possible to ensure its steady and timely cash availability, and it can change the duration of the credit period by altering the credit terms and collection policies. These terms might help a company decide which customers or vendors to allow a credit line.

4. Combine financial management strategies

Businesses may decide to use a combination of the abovementioned strategies, according to their financial situation. This may give them maximum monetary flexibility when implementing cash flow management. A company can minimise delays in making payments to various accounts by maintaining a constant balance in the cash flow statement and making purchases at desirable prices. By keeping an inventory record, a business may prevent stockouts and be able to create backup plans in case of a lack of financial resources.

Tips For Effective Cash Flow Management

Here are some tips for implementing cash flow management:

Collect payments on time. Businesses can practice effective cash flow management by conducting regular payment collections and billing customers and vendors with a credit line before the due date. This may allow a permanent cash flow, providing the organisation with constantly available working capital.
Implement modern techniques for payment collection. Organisations can use modern cash collection techniques, such as concentration banking, lockbox system and electronic data interchange to ensure efficient financial management. These techniques might help an organisation collect funds from multiple customers in one go and maintain an easily accessible record of all payments.
Track inventory and monitor costs. Keeping a check on payments to suppliers can help businesses monitor their expenses. By tracking the inventory, companies can gather data on what is selling, which may help them maintain a consistently stocked inventory.

Benefits Of Cash Flow Management

Here are a few benefits that cash flow management may have on an organisation:

Maintaining financial readiness: Cash flow management may enable a business to regularly meet its cash flow requirements, since it requires companies to track their incoming and outgoing monetary exchanges. It can also help companies to make investments and plan for other essential expenditures.
Encouraging business expansion: An adequate cash balance may allow companies to benefit from specific business opportunities. They can use the excess cash to expand the business by purchasing more equipment or hiring advanced talent.
Enabling smarter investments: Effective cash flow management can aid a business in saving significant funds by simply monitoring its inventory and pre-planning for specific situations. A company can use the excess cash to invest in marketable securities. These are highly liquid and you can quickly convert them to cash.