Basics of Cash Management – Cash Management Functions

Cash management is one of the key areas of working capital management.  Cash is the most liquid current assets.  Cash is the common denominator to which all current assets can be reduced because the other major liquid assets, i.e. receivable and inventory get eventually converted into cash.  This underlines the importance of cash management.

Read More: The Concept of Cash Management

The term “Cash” with reference to management of cash is used in two ways.  In a narrow sense cash refers to coins, currency, cheques, drafts and deposits in banks.  The broader view of cash includes near cash assets such as marketable securities and time deposits in banks. The reason why these near cash assets are included in cash is that they can readily be converted into cash.  Usually, excess cash is invested in marketable securities as it contributes to profitability.

Cash Management Functions

Cash is one of the most important components of current assets.  Every firm should have adequate cash, neither more nor less.  Inadequate cash will lead to production interruptions, while excessive cash remains idle and will impair profitability.

Functions of Cash Management

Cash management is concerned with minimizing unproductive cash balances, investing temporarily excess cash advantageously and to make the best possible arrangements for meeting planned and unexpected demands on the firm’s cash. Cash Management must aim to reduce the required level of cash but minimize the risk of being unable to discharge claims against the company as they arise. All these aims and motives of cash management largely depend upon the efficient and effective functioning of cash management. Cash management functions can be studied under five heads, namely, cash planning, managing cash flow, controlling cash flow, optimizing the cash level and investing idle cash. All these functions are discussed below in details:

1. Cash Planning

Good planning is the very foundation of attaining success. For any management decision, planning is the foremost requirement. Planning is basically an intellectual process, a mental pre-disposition to do things in an orderly way, to think before acting and to act in the light of facts rather than of a guess. Cash planning is a technique, which comprises of planning for and controlling of cash. It is a management process of forecasting the future need of cash, its available resources and various uses for a specified period. Cash planning, thus, deals at length with formulation of necessary cash policies and procedures in order to carry on business continuously and on sound lines. A good cash planning aims at providing cash, not only for regular but also for irregular and abnormal requirements.

2. Managing Cash Flows

The heading simply suggests an idea of managing properly the flow of cash coming inside the business i.e. cash inflow and cash moving out of the business i.e. cash outflow. These two are said to be properly managed only, if a firm succeeds in accelerating the rate of cash inflow together with minimizing the cash outflow. As observed expediting collections, avoiding unnecessary inventories, improving control over payments etc. contribute to better management of cash. Whereby, a business can conserve cash and thereof would require lesser cash balance for its operations.

3. Controlling the Cash Flows

As forecasting is not an exact science because it is based on certain assumptions. Therefore, cash planning will inevitably be at variance with the results actually obtained. For this reason, control becomes an unavoidable function of cash management. Moreover, cash controlling becomes essential as it increases the availability of usable cash from within the enterprise. As it is obvious that greater the speed of cash flow cycle, greater would be the number of times a firm can convert its goods and services into cash and so lesser will be the cash requirement to finance the desired volume of business during that period. Furthermore, every enterprise is in possession of some hidden cash, which if traced out substantially decreases the cash requirement of the enterprise.

4. Optimizing the Cash Level

A financial manager should concentrate on maintaining sound liquidity position i.e. cash level. All his efforts relating to planning, managing and controlling cash should be diverted towards maintaining an optimum level of cash. The foremost need of maintaining optimum level of cash is to meet the necessary requirements and to settle the obligations well in time. Optimization of cash level may be related to establishing equilibrium between risk and the related profit expected to be earned by the company.

5. Investing Idle Cash

Idle cash or surplus cash refers to the excess of cash inflows over cash outflows, which do not have any specific operations or any other purpose to solve currently. Generally, a firm is required to hold cash for meeting working needs facing contingencies and to maintain as well as develop goodwill of bankers. The problem of investing this excess amount of cash arise simply because it contributes nothing towards profitability of the firm as idle cash precisely earns no returns. Further permanent disposal of such cash is not possible, as the concern may again need this cash after a short while. But, if such cash is deposited with the bank, it definitely would earn a nominal rate of interest paid by the bank. A much better returns than the bank interest can be expected if a company deploys idle cash in marketable securities. There are yet another group of enterprise that neither invest in marketable securities nor willing to get interest instead they prefer to deposit excess cash for improving relations with banks by helping them in meeting bank requirements for compensating balances for services and loans.

Factors Determining Cash Needs 

Maintenance of optimum level of cash is the main problem of cash management.  The level of cash holding differs from industry to industry, organisation to organisation.  The factors determining the cash needs of the industry is explained as follows:

  1. Matching of cash flows – The first and very important factor determining the level of cash requirement is matching cash inflows with cash outflows. If the receipts and payments are perfectly coincide or balance each other, there would be no need for cash balances. The need for cash management therefore, due to the non-synchronisation of cash receipts and disbursements. For this purpose, the cash inflows and outflows have to be forecast over a period of time say 12 months with the help of cash budget. The cash budget will pin point the months when the firm will have an excess or shortage of cash.
  2. Short costs – Short costs are defined as the expenses incurred as a result of shortfall of cash such as unexpected or expected shortage of cash balances to meet the requirements. The short costs includes, transaction costs associated with raising cash to overcome the shortage, borrowing costs associated with borrowing to cover the shortage i.e. interest on loan, loss of trade-discount, penalty rates by banks to meet a shortfall in compensating, cash balances and costs associated with deterioration of the firm’s credit rating etc. which is reflected in higher bank charges on loans, decline in sales and profits.
  3. Cost of cash on excess balances – One of the important factors determining the cash needs is the cost of maintaining cash balances i.e. excess or idle cash balances. The cost of maintaining excess cash balance is called excess cash balance cost. If large funds are idle, the implication is that the firm has missed opportunities to invest and thereby lost interest. This is known as excess cost. Hence the cash management is necessary to maintain an optimum balance of cash.
  4. Uncertainty in business – Uncertainty plays a key role in cash management, because cash flows can not be predicted with complete accuracy. The first requirement of cash management is a precautionary cushion to cope with irregularities in cash flows, unexpected delays in collections and disbursements, defaults and expected cash needs the uncertainty can be overcome through accurate forecasting of tax payments, dividends, capital expenditure etc. and ability of the firm to borrow funds through over draft facility.
  5. Cost of procurement and management of cash – The costs associated with establishing and operating cash management staff and activities determining the cash needs of a business firm. These costs are generally fixed and are accounted for by salary, storage and handling of securities etc. The above factors are considered to determine the cash needs of a business firm.

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