June Topic: Cash Management
- Jun 18
- 4 min read
Overview
Managing cash in a business has many important nuances and takes into account all the aspects
of the Balance Sheet including current and long-term assets (cash, accounts receivable,
inventory, and equipment) as well as current and long-term liabilities (accounts payable, credit
cards, lines of credit, equipment financing etc.). Additionally, cash management takes into
account the company’s business model, capital structure, and growth forecast. Cash
management can be summarized into the following four main areas:
1. Liquidity
2. Working Capital
3. Financeable Long-Term Assets
4. Excess Cash
Below is an outline of considerations in each of these areas of cash management.
1. Liquidity
When working through cash management, liquidity is the first thing that comes to mind. This is
defined as cash on hand (in the bank account and undeposited funds) and available capacity in
credit facilities. Liquidity is “a company's ability to convert its assets to cash in order to pay its
liabilities when they are due.”1 In other words, it is the money a company has access to on a
given day in time.
Required available liquidity varies greatly according to the amount of working capital the
business requires to run as well as the growth trajectory of the company. A growing company
that requires a high level of working capital, such as a manufacturing business or a professional
service company with government contracts, will require more liquidity than average companies.
The key worry about liquidity is the possibility of a cash shortfall. Anticipate a period of
shortfall early – months in advance if possible. Banks are more likely to grant loans when money
is not needed immediately. If you don’t have enough cash on hand to cover your accounts
payable, make payroll first before deferring other payments. Talk to your suppliers and ask if
you can delay payment or have a payment plan. Offer discounts to clients for early payments.
2. Working Capital
Working capital is the difference between current assets (cash plus accounts receivable and
inventory) less current liabilities (credit card, accounts payable, and other near-term obligations).
Working capital takes into account the funds owed to the company and bills the company owes.
The value of a company’s working capital is the amount it has to work with during the next
approximately 60 days.
It is important to manage the time between services rendered/sales made and payment received.
Ensuring that you have enough cash on hand will free up your business for growth. Companies
with longer collection periods and shorter-term cost structures should do the following:
1. Understand the seasons of your cash flow.
2. Track your cash flow for 12 months and compare this year with last year.
3. Use a monthly cash flow forecast.
4. Work with customers to reduce collection time.
The following process is helpful for reducing collection time:
Invoice sent when services are rendered ➡ Statement sent at 30 days ➡ Phone call/email
to client at 30-60 days ➡ Statement and past due letter sent at 60 days ➡ Statement and
past due letter sent at 90 days ➡ Decision taken regarding collections
Decision Options: Forgiveness, Payment Plan, Collection Agency, Sue. Long-term non-payment
usually leads to an end of the working relationship with the client, unless you institute a policy of
paying in advance or Cash on Delivery (COD).
Remember to pay suppliers on time, but not before the due date unless they offer discounts for
early payments and you have enough cash on hand to make early payments.
3. Financeable Long-Term Assets
Some long-term assets, such as equipment and vehicles, may be financed. This is a more
complex capital structure and company philosophy issue. However, it directly affects the amount
of cash in the bank. The decision to purchase long-term assets out of excess cash, or to finance
them with long-term debt, can be distilled into four main factors:
1. Financeability of the assets and the strength of the company
2. Company philosophy regarding debt and risk
3. Additional opportunities to deploy cash in the business such as (1) marketing, (2)
software, (3) acquisitions, etc.
4. Distributions to the owners
4. Excess Cash
It is important not to keep all your eggs in one basket. Excess cash in the bank can be accessed in
a lawsuit if it is kept in the company. Excess cash should be reinvested or distributed. The
company should determine how much cash is optimal and make a plan for allocating excess
cash. This is based upon the company’s philosophy and the company’s forecasted cash needs. A
good general rule is that the company should have 2 months of expenses in the bank at the end of
the month. However, seasonality may sometimes cause this to vary from 1 to 4 times monthly
expenses. We recommend keeping a 16-week cash flow forecast that includes the following:
1. Cash at the beginning of the week
2. Collection of receivables
3. Collection of WIP (after services are rendered and the cash is collected, which may be 12
days out)
4. Collection of projects in the pipeline
5. Total cash in
6. Payments of payables
7. Recurring expense payments
8. Payment of debt
9. Purchases of equipment etc.
10. Total cash out
11. Net cash in/out
12. Projected cash at the end of the week
This analysis can provide comfort around cash management and can help to remove the
guesswork involved in cash forecasting and determining what is excess cash.
Summary
Summary
Much of the cash management process is based upon company philosophy and attitude toward
risk. It is important to stay ahead of cash management to avoid surprises. Lastly, the right cash
management process can help to reduce financing costs and put more cash in the pockets of the
company’s owners.
Don't hesitate to reach out to us for copies of prior editions from our extensive Monthly Topic archive. Other June Product Mix Monthly Topics include: Cash Forecasting, Working Capital, & Liquidity
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