What is Cash Management in Accounting?
It is the process of optimum utilization of cash for ensuring liquidity and profitability and includes proper collection, investment, and disbursement of cash. Cash is the primary asset used by companies to settle their obligations on a regular basis.
Cash flow management is the mechanism of tracking the inflow and outflow of cash in the business. The Cash flow statement is the primary tool to ascertain cash flow management. It includes cash received and cash paid during business operations and for investing and financing activities.
Objectives of Cash Management
- Cash Management is useful for the preparation of cash budgets and doing cash forecasts.
- It helps in determining the minimum cash balance to be maintained.
- It is used in balancing liquidity and profitability.
- Identifying the opportunity cost and investing accordingly.
- Curtailing expense;
Examples of Cash Management
Example #1
A computer manufacturing company, Abc Limited, uses supplier Alpha & Co. to purchase raw materials. Alpha & Co. has the policy of allowing credit of 30-days. Abc limited has $10 million in cash resources available and has to pay $2 million to Alpha & Co. after the 30-day period. However, after the 30-day period, it has an investment opportunity of $10 million.
If the company can renegotiate its terms with suppliers allowing more period, the delay in payment will allow the company to use cash in the investment and then pay off the amount to Alpha & Co. at a later date from cash generated from other sources. Thus, by proper cash management, it can take investment opportunities as well as maintain business operations.
Example #2
A Company has 120 days of inventory and receivables are due in 60 days. The payable terms are 30 days. The company will face a cash crunch as the funds are blocked in debtors and inventory, and the payables are due in a lesser time span.
In order to manage the cash prudently, the company either should speed up the realization of inventory or debtors; or it should renegotiate the payment terms with creditors. If the company fails to do so, it would need to borrow funds to fill the deficit.
Example #3
Beta limited has the policy to pay off its creditors in 60 days and gives a credit period of 30 days to its customers. Also, it doesn’t hold an inventory of more than 10 days. How should the company manage cash flows?
Since the payment is made in 60 days and realization is made for debtors and inventory in 40 days, there is idle cash for 20 days. In order to optimally utilize the same, the company should find an opportunity to invest and maximize profitability.
Importance
The company should ensure the sufficiency of cash to meet the current obligations and also make sure that there is no underutilization of funds. It has to strike a balance between liquidity and profitability. Also, the businesses depend majorly on debtors, and if a debt turns bad, it can impact the cash flows. Therefore, they also help in determining enough provisions for contingencies.
The following are the major benefits –
- Allows adequate availability of cash for business purposes;
- It helps in planning for capital expenditure.
- Enables to take advantage of opportunities by using idle cash.
- Facilitates investments;
- Preparing the business for unexpected outflows;
Limitations
- It is very time consuming and requires specified skills.
- It increases administrative and consultation charges for the experts hired to perform cash management.
- Lack of resources and risk-taking ability of the company.
Conclusion
- It is managing cash inflows and outflows.
- It is the key component for managing smooth business operations.
- The basic objective of cash flow management is to strike a balance between liquidity and profitability.
- A cash flow statement is a tool that helps in ascertaining cash flow management.
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