Effective Cash Management - Motives & Objectives for Holding Cash
Having an efficient and effective cash management policy in place is vital for a business no matter its net worth.
In theory, there are 3 motives for holding cash:
Cash balances are kept in order to meet routine cash needs of the business, such as the purchase of raw materials, payment of employees’ wages, etc…
Unanticipated cash demands require that an additional amount is kept to be able to meet such unexpected demands. Unanticipated cash demands can vary from unexpected rise in the prices of raw materials, debtors delaying their payment further than expected, strikes, etc…
Speculative balances are kept in order to allow the business to take advantages of any opportunities which may present themselves at unexpected times. Suppliers at times may try to attract companies by giving special discounts, but you must pay in cash.
Objectives of Cash Management
In order to ensure you meet the objectives of an effective cash management policy, the financial manager must ensure that the company meets the payment schedule and also minimize idle funds committed to cash balances.
Meeting Cash Balances
The financial manager must ensure he has enough cash in hand to pay suppliers, creditors, employees, shareholders, banks, etc…
Most financial managers at times go a step further and keep even more than required. This can be the result of various factors such as:
- Enhancing the company’s reputation – settling payments on time keeps creditors and suppliers happy
- Taking advantage of trade discounts by paying your debts on time
- Stronger negotiating power when dealing with suppliers
- Unexpected cash requirements can be met with no problem at all
Minimising idle balances
Too much cash tied up in idle balances waiting for something to happen involves an opportunity cost and hence loss of profits. As you minimise the cash balance, you increase the chance of a shortfall and of failing to meet your payments schedule. A company must always try to find a suitable cash management policy and this at times can be facilitated by having a cash budget in place. By doing so, a company could forecast its cash inflows and outflows for the coming period and thus estimate with reasonable precision the amount of cash balance that it must keep ‘idle’.
As a compromise, many companies try to hold some of their cash in short-term investments such as Deposit/Savings Accounts and Fixed Term Deposits Accounts. Government Securities are also attractive for those opting for marketable securities.
Cash is one of the most important aspects of a business. Lack of cash could and would probably lead to financial problems hence it is vital for a company to have a financial manager who is responsible for managing its cash to ensure it has enough to pay off creditors whilst also making profit from possible investment schemes with its idle cash.