What is cash management?

Cash management is the process of forecasting and monitoring cash inflows and outflows.

The goal is to generate sufficient cash inflows to pay all required cash outflows. 

The components of cash management are:

• Managing bank accounts: Managing bank account balances and determining the amount of excess cash not needed for company operations.

• Funding investments: Moving excess cash in and out of an investment account to maximize the yield earned on a cash position that can be used for operations and expenditures. Treasury management invests excess cash in short-term investments, including certificates of deposit and treasury bills.

• Making payments: Monitoring the total dollars needed, the due dates on invoices, and ensuring that accounts payable balances are paid on time. Bill payments may be processed using ACH, a checking account, a credit card, or other methods.

• Monitoring receivables: Tracking the dollar amounts and due dates of receivable balances and following up on collections when necessary. 

The cash management goal is to maximize excess cash balances and to control cash payments.

What are four cash transactions that effective cash management must address?

Here are four common cash transactions, and effective cash management must address each of these areas:

• Cash received from accounts receivable (AR): Customer payments increase the cash balance.
• Cash paid for accounts payable (AP): A disbursement to pay invoices reduces the cash balance.
• Cash flows from investing:  Cash outflows to purchase assets and cash inflows from asset sales.
• Cash flows from financing: Cash inflows from raising additional capital (stock or debt) and cash outflows for dividends or principal debt payments.

These are also four components of the statement of cash flows, which are explained in detail below. 

What's the difference between cash management and cash flow management?

Cash flow management manages accounts receivable and cash outflows to pay vendors and other invoices, including:

• Forecasting cash inflows and outflows 
• Making collection efforts on accounts receivable balances (automated alerts, emails, phone calls)
• Deciding when to take advantage of discounts on vendor invoices
• Paying invoices on time and managing vendor relationships
• Effective processes to manage financing and investing cash flows (planning asset purchases, negotiating debt terms)

On the other hand, cash management refers to decisions made about a specific cash balance at a point in time. Questions for cash management include: How much excess cash can be invested, and how is cash used to fund business operations? 

Why is cash flow management important?

Effective cash flow management is critically important for business success. Here are several reasons why:

• Paying obligations: Proper cash flow management ensures the business can pay all obligations on time. This strategy helps the business maintain strong vendor relationships.

• Minimizes need for capital: Cash flow management minimizes the need to raise additional capital for fund operations.

• Yield on excess cash: Managers can accurately forecast the amount of excess cash, make investment decisions, and maximize the interest rate earned on excess cash.

• Business expansion: The business can accurately forecast cash needed for a business expansion and determine the source of funds for expansion (excess cash inflows, raising more capital, etc.)

• Business valuation: Consistently strong cash inflows are an important metric for a business valuation. Reliable cash inflows demonstrate financial stability and make it easier to raise capital by issuing debt, or to borrow from a lender.

What is the cash flow statement, and why is it important?

The statement of cash flows reports on a company’s cash and cash equivalents for a specific period (month or year).

Cash equivalents are balances that can be quickly converted into cash, such as a money market account balance.

The cash flow statement is generated using these categories:

Beginning cash balance

Cash balance at the beginning of the month, per the balance sheet.

Cash flow from operating activities

Day-to-day business operations generate cash inflows and outflows.

These include cash collections from customers, processing payroll via ACH deposit, and paying for raw materials.

‍The vast majority of cash flow transactions are operating activities.

Cash flow from investing activities

Cash inflows and outflows from buying and selling business assets. Buying equipment requires a cash outflow, and selling a company vehicle produces a cash inflow.

Cash flow from financing activities

Cash inflows and outflows from raising capital and paying capital back to investors.

When equity or debt is issued, cash flows into the business. A dividend payment on equity or a bond principal repayment on debt are cash outflows.

The statement of cash flows uses the net cash balance (either positive or negative) from each of the three activities. 

Using the formula

The statement of cash flows is generated using this formula:

(Beginning cash balance) + (Net cash from operating activities) + (Net cash from investing activities) + (Net cash from financing activities) = (Ending cash balance)

The ending cash balance equals the cash posted to the balance sheet for the period. For example, the April statement of cash flows ending cash balance agrees with the April 30th cash balance in the balance sheet.

How does cash management work?

Managing cash requires a focus on internal controls and working capital:

Managing cash through internal controls

Internal controls are put in place to protect assets, including cash, from theft. There is a higher risk of cash theft than any other asset because of the number of cash transactions in a typical business.

A company may have dozens (or hundreds) of debit entries, direct deposit payments, and other online banking transactions. 

Segregation of duties is a control that protects cash from theft.

When duties are assigned to more people, the financial records will be more accurate and lower the risk of error. A small business with fewer employees may have more difficulty with segregation of duties.

To illustrate, assume that Sally owns Acme Construction company. Acme separates these duties between three different people:

• Custody of assets: Sally’s administrative assistant keeps the physical checkbook and is the only person with keys to the petty cash box. 

• Authority to move funds: Sally is responsible for signing all checks after she reviews each invoice and the supporting documentation.

• Recordkeeping: Bob, the controller, reconciles the cash account at the end of each month. Bob reconciles the account as soon as the bank statement is available to Acme after month end.

Keeping these three duties separate prevents one person from having too much control over the cash account. For example, Bob reconciles the cash account but cannot sign checks or have custody of the checkbook.

Every business should have these controls and others to protect cash from theft.

Cash management of working capital  

Working capital is current assets minus current liabilities and measures a firm’s ability to generate sufficient cash inflows to pay all current liabilities. In this context, “current” is defined as 12 months or less.

Current assets include cash and assets that will be converted into cash within 12 months. Accounts receivable and inventory are current asset accounts.

Current liabilities include accounts payable and other short-term financial obligations (line of credit, etc.). 

How does cash management relate to liquidity ratios?

Liquidity is the ability to generate sufficient current assets to pay all current liabilities, and working capital is a metric to assess liquidity. 

There are several other liquidity ratios, and cash management impacts these metrics. Liquidity ratios will improve when managers collect cash quickly and carefully monitor cash outflows.  

What are the major liquidity ratios?

Along with working capital, these two ratios are the most commonly used metrics to assess liquidity.

The current ratio

The current ratio formula is (current assets divided by current liabilities), and the ratio is closely linked to working capital.

Working capital is calculated as (current assets less current liabilities), and management aims to maintain a positive working capital balance. In other words, businesses always want the current asset balance to be greater than the current liability total.

Similarly, the current ratio formula is (current assets divided by current liabilities), and the company aims to generate a current ratio greater than one. If the current asset balance exceeds current liabilities, the ratio will always be greater than one.

Cash managers can use working capital or the current ratio to track liquidity.

The quick ratio

The quick ratio is (current assets less inventory) divided by current liabilities.

As defined earlier, current assets include cash and assets that will be converted into cash within 12 months.

‍The quick ratio assumes that inventory may take longer to convert into cash than accounts receivable and other current asset balances.

The quick ratio excludes inventory and divides the remaining asset balance by current liabilities. This ratio is considered a more conservative approach to liquidity analysis because the current asset balance is smaller. 

How to improve corporate cash management: 5 best practices

1. AP Automation to improve cash monitoring 

A platform like Rho offers cash management and capabilities like AP, banking and cash management services, expense, and corporate cards – all in one platform. 

Users can monitor every type of cash transaction in real-time. Financial officers, including treasurers, can create reports to monitor cash and calculate excess cash for investments.

• Treasury automation: Whether you are a CFO managing a lean finance team or a 1-person finance org, Rho can simplify and automate most of your corporate treasury processes for you. You don't need to be an expert on T-Bill ladders to generate substantive returns on you cash thanks to Rho.
• Investment monitoring: Rho scans the markets and adjusts your portfolio to ensure your investments are structured for safety, liquidity, and yield.
• Bank account monitoring: Rho technology monitors operating account balances and automatically transfers money to your bank account so that you always have enough cash on hand.

With Rho, managers have full control over cash flows and spending. AP automation controls who can spend dollars, the amount spent, and the type of expense. The business is less likely to go over budget. 

2. Improving the AR processes

Accounts receivable (AR) extends credit to customers who don’t immediately pay in cash.

If your AR balance is growing, you’re collecting cash more slowly. You can take action to reduce the average AR balance even as you grow sales.

Credit checks for new customers

New customers need a payment history with your business and may become slow-paying clients.

Many companies perform a credit check before doing business with a new customer to avoid this issue. This is common for B2B firms but may need to be more practical for B2C companies with hundreds of retail customers.

Ask for deposits

You may ask for an initial deposit on each purchase if you’re selling large ticket items or producing customized products and services.

Asking for a deposit signals whether or not the customer will pay on time. If you get customer pushback on deposits, it may be viewed as a red flag.

Automate the process

Make the payment process as seamless as possible.

Send invoices electronically and give customers the option to pay invoices online.

Create a formal collection policy

Successful businesses have a formal process to follow up on late payments. For example, your firm may email customers when an invoice is 30 days old and call clients if an invoice reaches 45 days old. Non-responsive customers should be sent to collections for more follow up.

The need to follow up with a customer is another red flag. If a client has to be contacted more than once regarding late payments, consider not doing business with them. The time and effort you spend following up on a late payment may not be worth the profit generated by the sale.

If your sales are increasing, monitor the days sales outstanding (DSO) ratio. The DSO formula is (average accounts receivable) / (net credit sales), and this metric tracks how many days it takes credit sales to be converted into cash.

3. Safeguard business bank accounts to protect against fraud

When both the banking and accounting functions are integrated within one platform, every cash transaction can be tracked and reviewed in real-time.

Transfers between bank and investment accounts are fully automated, and month-end reconciliations are performed electronically.  These controls reduce the risk of fraud, and management can detect unusual transactions immediately and follow up.

4. Invest excess cash

Every dollar of excess cash you generate can be invested to earn a higher yield. Implement systems that automatically sweep excess cash in and out of investment accounts, or use a treasury management company that can provide a return on available cash.

5. Refinance high-interest business debt

High-interest debt payments tie up cash, and you can improve cash flow by refinancing debt. Refinancing debt is easier if you pay timely invoices and build a strong credit history. 

You can borrow more, secure better payment terms, lower fees, and pay less interest when refinancing.

Wrap-Up: Choose the best cash management solution 

Why is cash management important? It helps businesses generate sufficient cash inflows to pay all required cash outflows and maintain proper financial health. 

To fully implement the best cash management practices, you need automation. And if you still need help choosing the best cash management software, let's make this easy.

If:

• End-to-end functionality to manage liquidity and forecast cash flows
• Ability to invest excess cash in government securities with 2-3 business day liquidity on U.S. Treasuries
• A scalable platform that grows as you grow

All wrapped up in unbeatable pricing and customer support available 24H Mon-Fri, 10-7pm ET on weekends sounds nice to you, 

Then, you should consider Rho.

Schedule time with a Rho payments expert today!

Competitive data was collected as of January 10, 2024, and is subject to change or update.

Investment management and advisory services provided by RBB Treasury LLC, an SEC-registered investment adviser. RBB Treasury LLC facilitates investments in securities: investments are not deposits and are not FDIC Insured • Investments are not bank guaranteed, and may lose value. Investment products involve risk and past performance does not guarantee future results.