Cash Management

Cash is money that is easily accessible either in the bank or in the business. It is not inventory, it is not accounts receivable, and it is not property. These might be converted to cash at some point in time, but it takes cash on hand or in the bank to pay suppliers, to pay the rent, and to meet the payroll. Profit growth does not always mean more cash.

Profit is the amount of money you expect to make if all customers paid on time and if your expenses were spread out evenly over the time period being measured. However, it is not your day-to-day reality. Cash is what you must have to keep the doors of your business open. Over time, a company's profits are of little value if they are not accompanied by positive net cash flow. You can't spend profit; you can only spend cash.

Cash Flow refers to the flow of cash into and out of a business over a period of time. The outflow of cash is measured by the money you pay every month to salaries, suppliers, and creditors. The inflows are the cash you receive from customers, lenders, and investors.

Positive Cash Flow
If the cash coming into the business is more than the cash going out of the business, the company has a positive cash flow. A positive cash flow is very good and the only concern here is managing the excess cash prudently.
Negative Cash Flow
If the cash going out of the business is more than the cash coming into the business, the company has a negative cash flow. A negative cash flow can be caused by a number of problems that result in a shortage of cash, such as too much or obsolete inventory, or poor collections on accounts receivable. If the company doesn't have money in the bank or can't borrow additional cash at this point, it may be in serious trouble.

A Cash Flow Statement is typically divided into three components so that you can see and understand both the internal and external sources and uses of cash.

  1. Operating Cash Flow (Internal)
    Operating cash flow, often referred to as working capital, is the cash flow generated from internal operations. It is the cash generated from sales of the product or service of your business. Because it is generated internally, it is under your control.

  2. Investing Cash Flow (Internal)
    Investing cash flow is generated internally from non-operating activities. This component would include investments in plant and equipment or other fixed assets, nonrecurring gains or losses, or other sources and uses of cash outside of normal operations.

  3. Financing Cash Flow (External)
    Financing cash flow is the cash to and from external sources, such as lenders, investors and shareholders. A new loan, the repayment of a loan, the issuance of stock and the payment of dividend are some of the activities that would be included in this section of the cash flow statement.

Good cash management means:

  • Knowing when, where, and how your cash needs will occur,
  • Knowing what the best sources are for meeting additional cash needs; and,
  • Being prepared to meet these needs when they occur, by keeping good relationships with bankers and other creditors.

The starting point for avoiding a cash crisis is to develop a cash flow projection. Smart business owners know how to develop both short-term (weekly, monthly) cash flow projections to help them manage daily cash, and long-term (annual, 3-5 year) cash flow projections to help them develop the necessary capital strategy to meet their business needs. They also prepare and use historical cash flow statements to gain an understanding about where all the money went.