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CASH MANAGEMENT

Introduction
Cash management is often described as the process by which an entity maximizes its available cash by the systematic management of cash collections and disbursements. However, cash management, as it is used in this article, goes beyond that description. Cash management also includes the use of excess cash to generate investment income or reduce interest costs and provides a system of controls over the collection, disbursement and use of cash. Properly applied cash management techniques will:

• Generate more available cash.
• Convert idle cash into an earning asset.
• Provide an adequate supply of cash to meet emergency needs.

Can Small Businesses Benefit from Cash Management?
The answer is yes. There is much more to cash management than simply picking up a few extra dollars of interest income. Even in small businesses, properly applied cash management techniques can significantly reduce the time between making a sale and collecting for it, make the timing of disbursements more effective, and maximize the earning potential of cash. In addition to these benefits, cash management also increases the awareness of cash collection, disbursement, and investment procedures, which has a positive effect on the control environment surrounding cash.

Cash Management Functions
Cash management can be divided into five functions:

• Administration. The administration function involves assembling the information needed for effective cash management.
• Collection. The collection function involves the accumulation and subsequent depositing of cash receipts.
• Cash Concentration. The cash concentration function involves the management of cash received and how it is made available for disbursements.
• Disbursement. The disbursement function involves managing cash disbursements for maximum efficiency.
• Reserve. The reserve function manages idle cash to ensure that investment income is maximized and interest costs minimized.

Responsibility for Cash Management Functions
In many larger corporations, a separate cash management or treasury department is responsible for performing the cash management functions. However, in most small businesses, the owner/manager or controller is responsible.

The five cash management functions and specific cash management techniques often overlap and cross various lines of authority.

This article addresses the Administrative Function of cash management.

The Administrative Function
The administrative function is primarily concerned with the following:

• Developing and analyzing cash management information.
• Coordinating the cash management functions.

Developing and Analyzing Cash Management Information
Cash management begins with developing useful cash management information and identifying areas for improvement. Performance measures, including both financial and nonfinancial measurements, can be used to identify weaknesses in the company's performance of cash management. Some of the commonly used performance measures for cash management include:

• Amount of discount offered customers for timely remittance.
• Average balances in noninterest bearing accounts.
• Average daily idle cash.
• Average number of days bills are paid before due date.
• Average time between receipt and deposit of funds.
• Collection period (accounts receivable divided by sales per day).
• Delinquent payment penalties as a percentage of purchases.
• Interest expense as a percentage of net capital.
• Length of cash cycle (time from payment for materials to ultimate collection of receivables from sales).
• Percentage of past due payables to total payables.
• Purchase discounts taken.
• Ratio of customer remittances by electronic means versus by check.
• Ratio of interest earned/average cash balances.

A frequently encountered problem with developing useful cash management information is choosing from among the seemingly endless possibilities of information that can be developed. Information that is expensive to develop may cost more than the potential savings that could be generated from it. This section discusses some of the common types of cash management information.

One of the first steps in cash management is to determine the liquidity needs of the entity. This often requires forecasting the company's cash needs. One of the more common pitfalls is to analyze the normal liquidity needs of the business but fail to consider an unusual cash requirement such as employee bonuses, purchases of fixed assets, lump-sum debt payments, etc. Inquiring of management and reviewing contracts and debt instruments are useful techniques to determine if an unusual or nonrecurring liquidity need exists.

Forecasts
What Is a Forecast? A forecast is a presentation of results based on management's assumptions reflecting conditions management expects to exist and the course of action it expects to take during the forecast period. Preferably, the forecast should show each activity by month. However, it might be necessary to show the activity for shorter intervals, such as weekly or even daily, when cash is especially tight or allowable margins of error are small.

Developing Assumptions. Before forecasting cash flow, the company's operating assumptions must be developed. This is done by considering the key factors that are expected to affect the company in the forecast period and developing assumptions that reflect its expectations for each of the key factors. The data used in developing the assumptions are normally derived from analysis of past performance and expectations about changes to be made in the future.

To make sure that all key factors and appropriate assumptions have been addressed, it is a good idea to prepare a forecasted income statement and balance sheet for the period. If the forecasted results are satisfactory, these statements can be used as a starting point for forecasting monthly cash flows.

Format. There are two general approaches to preparing cash flow forecasts: direct and indirect. The direct approach shows all activities on a cash basis. The indirect approach shows accrual basis results and then adjusts them to reflect the cash basis.

• Direct Approach. The direct approach is generally more meaningful than the indirect approach, but often is more time-consuming to prepare, and the accuracy of estimates decreases when the forecast is for a period longer than a month. In developing a cash flow forecast using the direct method, the income statement is recast on the cash basis and cash flows related to changes in balance sheet accounts are added to it.
• Indirect Approach. The indirect approach requires the forecasted income statement to be spread among the months based on expected activity. It may be suitable for periods of time greater than eight weeks or when inflows and outflows are constant since the method does not consider the timing of payments. Net income is then adjusted to (a) eliminate noncash items and (b) consider balance sheet changes affecting cash.

Analyzing Collection and Disbursement Float
What Is Float? The cash management term for the time or worth of payments or deposits in the process of collection is float. This definition has been extended to cover those measures of time and money when payments have not been collected or checks have yet to be paid. Usually, collection float works to a company's disadvantage, while disbursement float extends the amount of time your client has use of the funds. Overall, a company should attempt to minimize the amount of collection float and maximize the amount of disbursement float.

One of the primary responsibilities of both the collection function and disbursement function is controlling float.

Coordinating the Cash Management Functions
Another responsibility of the administration function is to coordinate the other functions. Since most small businesses do not have a formal cash management process or a large staff, there is a great deal of overlap in who performs cash management functions. However, even in some of the smallest businesses, there is some separation. The administrative function brings all of the information and techniques together.

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