Home»Blog»Banking»What is Cash Management And Why is it Necessary For Businesses?
What is Cash Management And Why is it Necessary For Businesses?
9 November 2022
Managing available capital can make sure that a small business stays afloat. Cash management is an integral part of a business. It is the part of an organisation that oversees how cash is collected and spent. But cash management is a weakness for many firms for several reasons.
Read on to know about cash management techniques and ways of managing your business flawlessly through it.
What is Cash Management?
The skill of controlling cash inflows and cash outflows is known as cash management. It is an essential step in making sure that any business can survive.
For this particular reason, banks and businesses frequently collaborate where banks are given custody of cash assets.
However, banks can assist companies with more than just holding cash; they can help them receive money from receivables and pay it forward under payables and other business expenditures.
Let’s understand this with the help of an example.
Let’s say that this is Company XYZ’s weekly average cash balance report:
Average Cash Balance (in INR)
As per the report, the total value is Rs. 1,00,000
If the annual interest rate is 12%, the monthly average cash balance would be:
Therefore, the Monthly Return on Average Cash Balance will be equal to INR 25,000 * 0.01 = INR 250
The business will use this to manage its cash flow.
Types of Cash Management
Here are some of the different types of cash management:
Cash Flow from Operating Activities: The cash flow statement of an organisation will show cash flow from operating activities, excluding cash flow from investing.
Free Cash Flow to Equity: After capital has been reinvested, cash is still available, known as a free cash flow to equity.
Free Cash Flow to the Firm: This metric is utilised in financial modelling and valuation.
Net Change in Cash: The term “Net Change in Cash” describes the overall cash flow change from one accounting period to the next.
Importance of Cash Management
The primary method used by businesses to settle their financial liabilities is cash. However, money is not the same as value. When all of a company’s assets are considered, it may be worth $1 million, but it might only have $50,000 in cash. Therefore, businesses need to be careful not to spend their money faster than they collect it as receivables.
If a company’s available cash falls short of the amount needed to cover its current liabilities, it might sell its assets to raise money or take out a loan. A business that doesn’t have enough cash to purchase inventory risks potential sales opportunities.
Listed below are some of the functionalities of cash management:
1. Inventory control
Inventory management is aided by effective cash management—lower liquidity results from trapped sales, which are indicated by higher inventory. As a result, a company should constantly concentrate on speeding up its cost of being out of stock to enable cash flow.
2. Receivables administration
To increase sales, a business concentrates on improving its invoices. However, the credit limit and period concerning cash receipts may be anywhere from 30 to 90 days. This indicates that even though the company has every sales record, the funds from such dealings are still pending.
Here, cash management’s job is to ensure that all receivables are paid as soon as possible to avoid a potential cash shortage. It also has a way to keep track of things, providing quick retrieval and letting the business know what might happen in the future.
3. Management of Payables
This is another essential part of the system of managing cash where discounts and cash credit terms can help businesses.
Objectives of Cash Management
Here are some of the main objectives of cash management:
1. Controls Cash Flow
The most vital objective of a cash management system is limiting your cash outflow as well as accelerating cash inflow. A business owner might always want to increase the amount of cash flowing into the business. However, minimising the cash outflow will result in reduced operational expenses.
An efficient cash management system that is integrated with cash management software will increase your real-time cash visibility which will give you greater control of your cash flow.
2. Efficient Cash Planning
The right cash management system will help you to optimise cash and plan effectively. It helps in planning the capital expenditure and determining the ratio of equity and debt to acquire finances. With the right planning, you will have the right amount of liquid cash so that you do not fall short of it.
3. Meet Unforeseen Expenses
The company might have to face certain unexpected circumstances like breakdown of machinery. Having surplus cash will help in coping with this situation in the best manner.
4. Ease of Investment
Cash management helps in optimum utilisation of available funds by creating an adequate balance between cash in hand and investments. It will help you to invest the idle funds in the right proportion at the right opportunity as it is one of the aims of cash management.
5. Avoiding Insolvency
If companies do not have proper planning for cash management, a situation might arise when the business will be unable to pay their bills. This situation may occur due to lack of liquid cash or not being able to make profit from the money available.
Benefits of Cash Management
The benefits of cash management are listed below:
Estimating cash profits is possible, as opposed to only gains from unpaid bills, sales of credit, etc.
It aids in the detection of cash theft.
It makes it possible to shorten the cycle of working capital.
It assists in rewarding those debtors who pay their debts more quickly.
It quickens an organisation’s activities.
Limitations of Cash Management
Poor cash flow management: Companies must be intensely aware of receipts and cash payment timings. They should also ensure that they receive ample amounts to pay forward as payables.
Delayed collection of cash: Revenue is estimated at the time of a transaction, but money might get delayed for up to 90 days. Companies may record high profits on the basis of their revenue. Still, they can face cash deficits if they have delayed sale collections even after running profits regularly.
Learning to adopt proper cash management techniques is essential for every business. They help even the most problematic financial issues to be resolved quickly. Cash management can be performed as per the need and nature of a business. It differs from manager to manager regarding their objectives for the business’s future.
Q1. Why do bookkeeping and cash management functions differently?
Ans: Cash management and bookkeeping don’t necessarily need to be separate in small businesses. Within the same department, the two tasks might be carried out. However, these activities are specialised in larger firms. This is so because bookkeeping requires a distinct skill set than cash management. Additionally, it’s crucial to separate tasks in larger businesses for operational control reasons: the person issuing the invoice shouldn’t also be the one handling the associated payment.
Q2. Are cash managers also involved in managing foreign exchange (FX)?
Ans: Small business cash managers also deal with foreign exchange, but FX management is a different field of expertise. For example, a case manager may have to open bank accounts in other currencies. The cash manager cuts operational costs by avoiding repeated transactions between the same currency pairs, which can lead to extra fees. This is not FX management. When researching market events that affect Treasury operations, the FX Manager often has to take on a more analytical or strategic role.
Q3. What did it mean for cash managers when the international bank account number (IBAN) was used?
Ans: When the IBAN, a new standard for bank account numbers, was implemented a few years ago, it made sending money electronically across borders easier. Theoretically, it lets businesses run with fewer bank accounts, making managing cash easier and cheaper. However, even though the IBAN is easy to use, some companies have more than one account in a foreign bank. They do this because they believe that doing business locally requires using a local bank.
Before you go…
Looking for instant 🚀 personal loans 24*7 anywhere, anytime? Get personal loans up to ₹20 lakh starting at 9.9% p.a. Install the Navi app now!!
Or, maybe you’re looking to buy that house you’ve been eyeing 🏠 and you need a loan of up to ₹5 crore. Install the Navi app now and get instant in-principle approval right away! Interest rates starting at 8.39% p.a.
How about an affordable health insurance policy👨⚕️ starting at a monthly premium of just ₹235? Install the Navi app now and get your policy in under 2 minutes.
Instead, want to put your savings into action and kick-start your investment journey 💸 But don’t have time to do research. Invest now with Navi Nifty 50 Index Fund, sit back, and earn from the top 50 companies.
Disclaimer: Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information, and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
Vikram Kirloskar Origins – From Bicycle Repair Shop to Toyota
Facial Recognition-based Entry System in Airport Launched. Know More!
15 Best Christmas Gift Ideas Even Santa Wouldn’t Ignore
RBI Launches Digital Rupee – Is it Like Crypto?
The G.O.A.T. – Messi’s 7 Life-Changing Quotes You Can’t Ignore
Mercedes or SIPs – Indians Tweet Their First Choice
How to Open Demat Account: Fees, Eligibility, Documents
Udd Gaye Totey: 9 Funny Tweets that Got Indians ROFL
10 Best Places to Celebrate New Year 2023 in India
We are a diverse group of writers, editors and Subject Matter Experts striving to bring the most accurate, authentic and trustworthy finance and finance-related information to our readers. Our mission is to simplify jargon and industry lingo. We believe sharing knowledge through relatable content is a powerful medium to empower, guide and shape the mindset of a billion people of this country.
What is a Secured Credit Card and How to Apply for One?
If you do not have a good credit score or are new to credit cards, getting a secured credit card co...Read More »
What is Personal Banking: Types, Benefits and Services
Personal banking typically includes checking accounts, savings accounts, money market accounts, and...Read More »
Increase Credit Card Limit – How To do It and Its Benefits
The credit card limit is the maximum amount of money you can spend using your credit card. In other...Read More »
What is a Credit Card Balance Transfer – List of Cards That Offer & How To Do it?
Are you paying a heavy interest rate on your credit card? There’s a solution to pay the amount du...Read More »
What is Price Skimming and How does it work?
Price skimming is a price determination strategy whereby firms initially charge a higher price for ...Read More »
What are Virtual Debit Cards – Benefits, Usage and How to Apply?
Virtual debit cards are digital forms of physical debit cards that store all vital payment informat...Read More »
Best Credit Card Offers in India in 2023
Credit card offers are incentives offered to credit cardholders when they use the cards to make pur...Read More »
Understanding Risk-Weighted Asset (RWA) and its Calculation in Banking
Risk-weighted asset or RWA is a banking term that refers to an asset classification system to deter...Read More »
List of 10 Best Savings Accounts in India
A savings account keeps your money safe, and lets you earn interest every quarter. There are many b...Read More »
What is Credit Appraisal – Eligibility, Benefits & How It is Done?
Ever wondered why loans get approved but also sometimes get rejected? Well, every bank has its own ...Read More »
Debt Trap: Meaning & How to Avoid Falling in It
Piling up debt could bring unnecessary stress. Having multiple loan EMIs and credit card bills to c...Read More »
How to Apply for Debt Consolidation Loans and What are Its Benefits?
If you have multiple loans, taking out a single loan to pay them off is known as a debt conso...Read More »
Diwali 2022: Diwali Holidays – The Festival of Lights
The ‘Festival of Lights’ is one of the biggest and most anticipated festivals in India. This is...Read More »
Best Index Funds – Top 20 Index Funds in India
Index funds replicate the performance of a stock market index, such as the Sensex or Nifty 50 to ge...Read More »