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Management of Cash Flows: The lifeline of a business organization

All businesses, whether large and small, rely on inflows of cash emanating from sales, investments, loans, and other sources. These cash inflows are offset by cash outflows, or disbursements needed by the enterprise to fund its material inventories, payroll, capital expenditures, investments, and other operational expenses.

Cash flows represent the lifeline of any business, and positive cash flow is necessary for the survival of a business entity. However, maintaining a positive balance of cash flows can pose a challenge for the business and its management. When a business runs into cash flow challenges, it is not able to pay its routine bills on time, thus, risking a decrease in its credit line or higher interest rates.

The Need for Cash

Over recent years, the demand for funds for expansions coupled with high-interest rates, foreign exchange volatility, and the increasing volume of financial transactions have necessitated the requirement of efficient management of cash. Business firms face cash problems when there is a lack of synchronization between cash receipts and cash payments.

In determining the quantum of cash or liquidity required in a business organization, the below-mentioned needs form the basic foundation:

• The transaction needs: In any business, cash facilitates the meeting of the day-to-day expenditures and other payments of debt. For instance, cash is needed to make purchases, pay expenses, taxes, salaries, dividends, etc. Usually, the inflows of cash from routine business operations should be sufficient for the purpose of meeting these payments. However, at times, this cash inflow may be temporarily blocked. Thus, in those cases, it is only the reserve cash balance that can enable the business firm to make its payments on a timely basis.

• Speculative needs: Another very important segment that requires a considerate utilization of the company’s cash balance is its speculative needs. Cash may be held by businesses in order to take quick advantage of some profitable opportunities which may arise before the company over time. But, they may be lost for want of readily available cash or settlement. For instance, the prices of raw materials may fall temporarily, and a business firm may want to make acquisitions at such prices.

• Precautionary needs: Proper cash planning is necessary to meet the company’s precautionary needs as well. Cash may need to be held by business enterprises to act as a reservoir for providing safety against unanticipated events or contingencies. The cash maintained for meeting contingency needs is unproductive, or it remains ideal. However, such cash may be invested in short-term or low-risk marketable securities which are readily convertible into cash or can provide cash as and when necessary.

What is Management of Cash?

For any business organization, the management of cash flows involves an efficient cash collection process and managing the payment of cash both inside the organization and to third parties. This can be achieved when there may be complete centralization within a group treasury, or the treasury may simply suggest subsidiaries and divisions on policy matters, namely, collection/payment periods, discounts, etc.

Management of cash also deals with planning and sourcing the company’s short, medium, and long-term cash needs. It plays an important role in taking the decision on capital structure and forecasting future interest and foreign currency rates.

The exercise of management of cash also encompasses overseeing surplus funds in an investment portfolio. The investment policy will consider future needs for liquid funds and acceptable levels of risk as contemplated by company policy.

Management of cash flows is one of the most important functions of the finance manager. It is concerned with tasks relating to the managing of:

• Cash flows into and out of the business firm
• Cash flows within the business firm, and
• Cash balances held by the business firm at a certain point of time by financing deficit cash or investing surplus cash

Objectives of Management of Cash Flows

The scheme of cash management of a business organization creates a delicate balance between the twin objectives of liquidity and costs. The major objectives of management of cash flows for a business entity include the following:

• To provide adequate cash to each of its business units
• To ensure that no funds are kept blocked in idle cash, and
• To ensure that the surplus cash in business (if any) is properly invested in order to maximize the returns for the organization
• To fulfil its working capital requirements on a timely basis
• To plan its capital expenditure decisions and ensure optimum utilization of available funds
• To avoid the situation of insolvency

Cash Planning and Cash Flow Budgeting

Cash Planning is a technique of management of cash flows which aims to plan and control the usage of cash. It seeks to protect the financial conditions of the business firm by generating a projected cash flow statement. Such a projected cash statement is derived from a forecast of expected cash inflows and outflows for a particular period. This process may be executed periodically either on a daily, weekly, or monthly basis. The period and frequency of cash planning normally vary with the size of the firm and the philosophy of management. As companies grow and business activities become complex, cash planning becomes inevitable to achieve enduring success.

To estimate the requirement of cash, Cash Budget is one of the most significant tools to plan for and control cash receipts and disbursements. It represents the complete cash requirements of a business entity during a given budget period. The main purposes served by a cash budget comprise the following:

• It locates the time periods where there might be either a shortage of cash or an exorbitantly large cash requirement. Thus, it co-ordinates the timings of cash needs.
• Likewise, it also helps to pinpoint the time periods where there is likely to be excess cash available.
• It allows the business firm which has sufficient cash to take advantages like cash discounts on its accounts payable.
• It helps to plan or arrange adequately needed funds (avoiding excess/shortage of cash) on favourable terms.
• It allows the firm to decide to invest surplus cash in marketable securities and earn profits therefrom.

Management of cash flows: Managing Cash Collection and Disbursements

Having prepared the cash budget, the finance manager of the business entity must then ensure that there is not a significant deviation between the projected cash flows and the actual cash flows. To realize this, the efficiency of cash management will have to be improved through exercising appropriate control of cash collection and disbursement. In fact, the twin objectives in managing the business cash flows should be to accelerate cash collections as much as possible and to decelerate or delay cash disbursements.

Accelerating Cash Collections

A business enterprise can preserve cash and decrease its requirements for cash balances if it can speed up its cash collections. This can be done by issuing sales invoices quickly or by minimizing the time lag between payment of the bill by a customer, the collection of cheque, and the availability of funds for the firm’s use.

Float refers to the time periods which influence cash as it moves through the different stages of the collection process. For instance, billing float is the time lag between the actual sale and the mailing of the invoice by the seller to the purchaser. Similarly, banking processing float is the time from the deposit of the cheque to the crediting of funds in the sellers’ account. To speed up the cash collection process and to reduce float time, a business firm can use a decentralized collection system called concentration banking and lock box system.

Concentration Banking: The method of concentration banking is one of the important and most popular ways of reducing the size of the float. Here, the business enterprise establishes a number of strategic collection centres in various different regions rather than having a single collection centre at the head office. With this kind of system in place, the period between the time a customer mails in his remittances and the time when they become spendable funds with the selling entity gets reduced. Payments received by all collection centers are deposited with their respective local banks, which in turn, are transferred to the concentration bank of the head office. The concentration bank, with which the entity has its major bank account of surplus funds, is normally situated at the headquarters.

Lock Box System: Another popular means used by companies to accelerate the flow of funds is a lock box system. While under concentration banking, remittances are received by a collection centre and deposited in the bank after processing, the lock box system strives to eliminate the time between the receipts of remittances by the company and the deposit in the bank.

In this kind of arrangement, the business enterprise rents the local post-office box and authorizes its bank at each of the locations to pick up remittances in the boxes on behalf of the company. The customers are also billed with proper instructions to mail their remittances to the lock boxes only. The bank then picks up the mail several times a day and deposits the cheques in the business entity’s account. Such a process releases the company from the burden of handling and depositing the cheques. In other words, the lag between the time cheques are received by the business entity and the time they are actually deposited in the bank gets eliminated. However, the major drawback of the lock box system is concerned with the cost of its operation. These lock box arrangements are generally not profitable if the average remittance is small for a company since the cost is almost directly proportional to the number of cheques deposited.

Managing Cash Disbursements

Akin to exercising efficient management over cash collection processes, it is also important to have effective control over cash payments in order to achieve an overall faster turnover of cash. This is possible only by making payments by the company on the due date and making excessive usage of drafts or bills of exchange instead of cheques.

The availability of cash in a business concern can be maximized by playing the float. For example, a firm accurately predicts the time when the cheques issued by it to the suppliers will be presented for encashment. With this, the firm utilizes the float period to its advantage by issuing more cheques but having in its bank account only so much bank balance as will be just sufficient to honour those cheques which are actually expected to be presented on a particular date.

Moreover, the business enterprise may also make payments to its outstation suppliers by cheque and send it through the mail. The delay in transit and collection of the cheque will be used to increase the float.

Other Techniques for Management of Cash

Besides, accelerating collection of accounts receivables and stretching of accounts payables, the company should also look for the ways of reducing its operating cost to maintain a good cash flow in the business and improve its profitability. The enterprise should try to extend the payment of dues to creditors or suppliers by acquiring an extended credit period from them.

Furthermore, regular cash flow monitoring by keeping an eye on the cash inflows and outflows, prioritizing the expenses and reducing the debts to be recovered, makes the businesses’ financial/liquidity position sound. The widely used banking services such as a business line of credit, cash deposits, lockbox account and sweep account must be incorporated into the business efficiently and intelligently. In addition, up-gradation with technology and digitization makes it convenient for the business organizations to maintain the financial database and spreadsheets to be assessed from anywhere anytime.

Optimum Cash balance

A business firm must make efforts to maintain an optimum cash balance to cater to its day-to-day operations. It may also carry on some additional cash as a buffer or safety stock. The amount of cash balance will be dependent upon the risk-return trade-off. The business should maintain an optimum level of cash balance, i.e. just enough to meet its requirements, i.e. neither too much nor too little cash balance.