Cash is the lifeblood of a business, and a business needs to generate enough cash from its activities so that it can meet its expenses and have enough left over to repay investors and grow the business. While a company can fudge its earnings, its cash flow provides an idea about its real health.
Key Takeaways
- Cash management encompasses how a company manages its operations or business activities, financial investments, and financing activities.
- A company has to generate adequate cash flow from its business in order to survive, meaning it is able to cover its expenses, repay investors, and expand the business.
- In addition to generating cash from its activities, a business also needs to manage its cash situation so that it holds the right amount of cash to meet its immediate and long-term needs.
Cash Is King
By generating enough cash, a business can meet its everyday business needs and avoid taking on debt. That way, the business has more control over its activities. In a situation in which a business has to take on debt to meet its expenses, it is likely that its debtors will have a say in how the business is run. If they have contrary opinions to the management’s, that could be an impediment to the way management executes its vision for the business.
Without generating adequate cash to meet its needs, a business will find it difficult to conduct routine activities such as paying suppliers, buying raw materials, and paying its employees, let alone making investments. And it should have sufficient cash to pay dividends and keep its investors happy. Some companies also use their cash to engage in share buybacks to reward investors.
Improving Cash Management
Even if a company is making a profit by making more revenue than it incurs in expenses, it will have to manage its cash flow correctly to be successful. A company’s cash flow is tied to its operations or business activities, to its investment activities (such as the purchase or the sale of capital equipment), and to its financing activities (such as raising debt or equity funding or repaying such funding). The cash that a company generates from its operations is tied to its core business activities and provides the best opportunities for cash flow management.
Areas that offer possibilities for better cash management include accounts receivable, accounts payable, and inventories. If a company were to grant credit indiscriminately, without ascertaining the creditworthiness of its customers, and not follow up on tardy payments, that would lead to a slower and smaller inflow of cash, as well as unpaid bills. That is why it is important to have a credit policy and follow up on tardy payments. On the other hand, when it comes to accounts payable, it is a better approach to cash management to pay suppliers later rather than earlier. As well, it is important not to have too much cash tied up in inventories but to have on hand just enough inventories for the immediate needs of the business.
Profits don't tell the whole picture since a company can find ways to make its earnings look better. But with cash flow, the firm's true wellbeing is on the table.
Striking the Right Balance
There is a balance between having too much cash on hand, out of precaution, and having an inadequate supply. If a business has too much cash, it is missing out on opportunities to invest the cash and generate additional earnings. On the other hand, if it doesn’t have an adequate supply of cash, it will have to borrow the money and pay interest or sell off its liquid investments to generate the cash it needs. If the business expects to generate a better return on its investments than it pays in interest on its borrowings, it might decide to invest its surplus cash and borrow any additional money it needs for its activities. In analyzing a company’s balance sheet, certain ratios such as a firm’s acid-test ratio or the ratio of its most liquid current assets(including cash, accounts receivable, and marketable securities) to its current liabilities provide an idea about its cash management. While a ratio of greater than one indicates a healthy current assets situation, a very high ratio could indicate that the firm holds too much cash or other liquid assets.
FAQs
By generating enough cash, a business can meet its everyday business needs and avoid taking on debt. That way, the business has more control over its activities. In a situation in which a business has to take on debt to meet its expenses, it is likely that its debtors will have a say in how the business is run.
Why is cash management key to business success? ›
Why is cash management important to my business? When it comes to creating and sustaining a company's financial stability, cash management is a key component. Since “cash” is the primary asset used to pay obligations (whether you're an individual or company), it must be managed accordingly to maximize earnings.
Why cash flow is so important to running a successful business? ›
Cash flow management means tracking the money coming into your business and monitoring it against outgoings such as bills, salaries and property costs. When done well, it gives you a complete picture of cost versus revenue and ensures you have enough funds to pay your bills whilst also making a profit.
What is one reason why cash is important to a small business? ›
The management of cash is very important as cash allows a business to pay its bills. The main cash payments a business makes include: payments to suppliers. payments to employees.
Why is it important for a business to have enough cash? ›
Cash is the lifeblood of any business, as it is essential for day-to-day operations, growth, and survival. Without cash, a business cannot pay its bills, invest in new equipment or inventory, or even meet payroll.
Why cash management is key to business success investopedia? ›
Cash management encompasses how a company manages its operations or business activities, financial investments, and financing activities. A company has to generate adequate cash flow from its business in order to survive, meaning it is able to cover its expenses, repay investors, and expand the business.
What are the advantages of cash management? ›
Effective cash management is crucial for businesses as it ensures sufficient liquidity to meet daily operational needs, pay bills, and invest in growth opportunities. Ensuring sound cash management practices is the best way to ensure financial stability and make strategic decisions for growth.
What is cash management in business? ›
Cash management is the monitoring and maintaining of cash flow to ensure that a business has enough funds to function. Investments, bill payments, and unexpected liabilities can affect a business' inflows and outflows, and in turn their cash management.
Is cash flow the key to success? ›
Cash flow management is the cornerstone of any successful business, acting as the heartbeat that ensures its vitality and longevity. At its core, cash flow management involves the meticulous monitoring of cash movement within a business, encompassing both inflows and outflows.
What are two benefits for a business of managing cash flow effectively? ›
The advantages of managing cash flow are straightforward: You will know where your cash is tied up. You can identify potential bottlenecks and act to reduce their impact on your business. It will assist you in forward planning.
"Paying in cash typically saves the small business owner between 2% and 3% of the transaction price in interchange fees. Interchange fees are the fees charged by the bank, the processing company and card network to process a credit or debit card transaction," Johnston said.
Why is cash control extremely important for a business? ›
For young companies, cash management is essential to ensure the company is not growing too quickly. Without an adequate cash management system, a company runs the risk of running out of cash, receiving a poor return on their invested cash or even failing a CRA audit, which could jeopardize the company's future.
Why is cash important to a business a level business? ›
CASH IS KING
A business that runs out of cash is likely to become insolvent will fail without a further injection of finance. By contrast, a business that generates strong profits and turns them into positive cash flow is in a much stronger position to achieve all of its objectives.
How important is cash flow to a small business? ›
It's clear that cash flow is crucial for companies of all sizes, but especially small businesses. A study found 82% of businesses that fail do so because they have cash flow issues. Make sure you're not one of them by taking action with the right tools.
Why is cash flow management so important? ›
Prudent cash flow management contributes to the financial stability of a business. It helps cushion the impact of unexpected expenses or revenue fluctuations, reducing the risk of insolvency or financial distress.
Why is operating cash flow important? ›
Operating cash flow provides a clear picture of the reality of the business operations. For example, a large sale boosts revenue, but if the company is having difficulty collecting the cash, the sale is not a true benefit for the company.
Why is cash management important in decision making? ›
Efficient cash and liquidity management, helps businesses to gain cash visibility and provides a clear picture of their financial health. Cash visibility provides insights into whether there is a cash surplus or deficit, allowing stakeholders to make decisions promptly.
What is the main objective of cash management? ›
Cash management is the monitoring and maintaining of cash flow to ensure that a business has enough funds to function. Investments, bill payments, and unexpected liabilities can affect a business' inflows and outflows, and in turn their cash management.
What is the impact of cash management on business profitability? ›
Data were analyzed using mean, correlation and regression models. Study found that Cash management has an insignificant but positive effect on profitability. It clarifies that conversion cycle, cash flow and inventory manage positively effects to the profitability but the effect is nominal.
