Cash management tools provide powerful insights into cash flow. With this information, businesses can optimize their financial performance and make decisions based on accurate information.
While cash management is often discussed in terms of business operations, it can also be applied to individual finances in various ways.
This overview will cover the definition of cash management, its primary goals, key principles and strategies, and more.
What is Cash Management?
Cash is collected, analyzed, and managed through a process known as cash management, sometimes called treasury management.
Without effective cash management, it is difficult for individuals and businesses alike to meet their financial obligations and maintain financial stability.
Cash management is not simply tracking cash, either.
It is a strategy for managing the inflows and outflows of money into and out of an organization to ensure enough liquidity to pay bills, make investments, and cover contingencies.
Fundamentally, good cash management is about balancing short-term with long-term goals and using that knowledge to make the best decisions for the company and its employees.
Learn about long-term cash flow forecasting here.
Strong cash management can help companies and individuals:
- Avert liquidity crises.
- Improve their financial standing.
- Strengthen their decision-making processes.
Strategic knowledge of cash positions helps you make sound investment choices, decide when and where to cut back, and know what expenditures are necessary for growth.
Ultimately, a well-defined cash management system provides the basis for companies to survive through hard times and capitalize on opportunities.
What Is The Main Objective Of Cash Management?
Cash management is about maximizing liquidity while minimizing the costs of funding.
This means managing the business to ensure it always has the cash it needs to meet its immediate commitments while also timing cash inflows and outflows to maximize returns on surplus cash.
A cash management system that works well serves the business twofold:
- In the short term, it mitigates the risk of financial distress by ensuring a business has the cash it needs. In the long run, it positions a growth business.
Maintaining liquidity is necessary to continue operating effectively and meeting
payroll, suppliers, and investment obligations.
- However, it also means ensuring the organization can forecast cash requirements accurately and plan its financial activities and strategy to reflect those needs.
If a business focuses on these goals, it can better manage cash, adapt to changing market conditions, and support strategic initiatives.
Basic Principles: Smart Cash Management Strategies to Use
Cash management involves grasping certain principles and then implementing them.
These include:
- Monitoring cash flows.
- Forecasting.
- Working capital management.
- Establishing internal controls.
1. Monitoring Cash Flows
Monitoring cash flows is the starting point of cash management.
This is done by regularly preparing cash flow statements, which show cash inflows and outflows in real time to give a company a view of its cash position. This helps the organization decide when to spend, when to invest, and when to save.
2. Forecasting
Forecasting cash flows is just as important.
Predicting future cash positions—based on history and expected business activities—helps businesses prepare for cash shortages and plan for large investments and expenditures.
3. Working Capital Management
This involves balancing current assets and current liabilities. Positive working capital suggests the business is financially strong, but negative changes in working capital can lead to cash flow problems.
This is why companies need to assess the needs of their working capital carefully. Then, they will have the resources necessary to run their businesses efficiently.
Access our free working capital template here. It enables calculation by subtracting current liabilities from current assets.
4. Implementing internal controls
Finally, this step ensures cash management processes are secure and compliant with any relevant regulations.
Accounting controls and internal audits also help prevent embezzlement and other kinds of financial mismanagement.
How Does Cash Management Work?
As the name suggests, cash management involves many steps and activities that, in combination, ensure financial sustainability and operational efficiency.
Data Collection and Analysis
Cash management begins with data collection and analysis. In this step, organizations collect and analyze financial data from their bank accounts and other systems.
An overview of the cash received and spent allows an organization to make informed decisions about spending and investing.
Bank Connectivity and Reporting
Bank connectivity allows for the real-time capture of cash data, while reporting allows pushing cash data to cash management software automatically.
Integrating banking systems with cash management tools enhances the accuracy of cash reporting by automating and providing up-to-date visibility on cash positions.
Additionally, integrating multiple accounts into a single source of truth eliminates manual input in reporting, which reduces the risk of data entry and reporting errors.
Don’t miss this article next: Real-Time Reporting Tools for Finance, Operations, Payroll.
Cash Flow Forecasting
Cash flow forecasting is another fundamental step in cash management. It allows for the projection of cash flows in future periods based on historical information and current activities.
This is especially useful when mitigating or managing liquidity crises, especially regarding strategic planning and resource allocation.
Vendor Management
Categorizing and analyzing spending patterns with vendors allows organizations to strengthen relationships and find ways to save on costs.
Knowing what goods or services are being purchased, when, and how often helps organizations negotiate better terms with suppliers and manage expenditures more efficiently.
What Good Cash Management Can Do for You
The benefits of good cash management are not limited to businesses. Entities and individuals can use good cash management to maximize their liquidity.
1. Maximize Liquidity
Good liquidity management helps the organization maintain adequate cash balances to meet its obligations, facilitating its operational continuity and growth initiatives.
2. Cost Minimization
An organization can reduce funding costs and increase profitability by optimizing cash use and avoiding unnecessary borrowing.
This discipline in using funds will help organizations direct more capital to profitable investments, thus increasing their return on investment.
3. Financial Agility
Healthy cash management also supports growth by helping companies achieve financial agility to embark on new projects and initiatives with a clear understanding of their cash flow.
When cash flows are well-managed, companies can make wise decisions about capital expenditures, hiring, and expansion.
4. Risk Mitigation
Another advantage of effective cash management is better risk management. When figures and forecasts are accurate, organizations can better evaluate their exposure to risks and take steps to mitigate them.
This helps them keep their finger on the pulse, react to changes in market conditions, and avoid problems.
Real World Examples: Cash Management in Action
Let’s turn our attention to two real-world scenarios that demonstrate the potential outcomes of poor vs. effective cash management.
Scenario #1: Poor Cash Management
A small manufacturing business experiences a surge in orders and commits to a large contract. The owner spends heavily on materials and labor upfront, assuming the incoming revenue will cover it.
The problem is, the client’s payment isn’t due for 60–90 days.
Because the owner failed to forecast cash flow or secure short-term financing, the company ran out of cash midway through the project. They struggle to pay suppliers and employees on time, and ultimately must take an expensive emergency loan to stay afloat.
Scenario #2: Effective Cash Management
An individual takes a disciplined approach to personal finance by creating a monthly budget and setting aside a portion of each paycheck into a savings account. Over time, they build a modest emergency fund.
One year, their car’s transmission fails, and the repair bill is $1,000.
Thanks to their cash management habits, they have enough funds saved to pay for the fix immediately. They avoid putting the expense on a high-interest credit card or taking out a loan.
What Are the Most Common Cash Management Challenges?
Even with so many benefits, certain challenges can get in the way of effective cash management.
1. Complexity
The first is that cash flows can be very complex.
With multiple accounts and varying cash flows, tracking financial performance can be very confusing. If not tackled effectively, this can result in missed opportunities and poor financial management.
2. Inadequate Cash Flow Forecasting
Another common problem is poor cash flow forecasting. If the forecast is inaccurate, a cash crunch can occur, and in the worst cases, it can cause the company to default on its obligations.
Reasonable forecasting is crucial for a company to have the capacity to be both prepared for changes in cash inflows and effectively respond to shifting situations.
3. Discrepancies and Misinterpretations
A third and often underestimated challenge is a poor understanding of the cash flow cycle. Many organizations fail to recognize the distinction between profit and cash, resulting in the mismanagement of cash and the implementation of ineffective cash management strategies.
If you are not clear about when cash is generated from sales and when accrued costs are paid, you will be blind to potential cash flow problems until they spiral out of control.
Monitor the solvency ratios, including the quick or current ratios, to assess liquidity. If these ratios are not monitored, the company may end up in a tricky financial situation and be unable to pay its stakeholders back.
We share strategies for presenting budgeting forecasts to stakeholders here.
Conclusion: How Can You Improve Cash Management in Your Business?
Cash management aims to ensure a company has the cash it needs to pay its obligations and minimize the amount of cash it needs to set aside to honor those obligations.
If you’re eager to improve cash management in your business, turn to cash management tools—but not just any tool will do.
Deploying sophisticated cash management tools provides a company with better visibility into its liquidity, enhanced decision-making capabilities, and deeper insight into its cash flows.
This facilitates more proactive cash positioning and management of a company’s liquidity. In turn, this can mean reacting much quicker to financial opportunities or threats.
Do you want to see Datarails Cash Management solution in action?
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