Among the essential qualities for maintaining a structurally sound entity lies cash management, for it helps in strategizing key elements within a business. Efficient cash management enables the business to satisfy its financial obligations, invest in opportunities to expand the business, and respond to changes in the economic environment. In this article, two ratios pivotal to cash flow management are discussed alongside a few principles for effective cash management and concrete advice for cash flow problems.

The Cash Ratio and Current Ratio are the two ratios that are most relevant to measuring a business’s liquidity and solvency position.

Current Ratio

Definition: The ratio reflects the capacity of a business firm to meet its short-term liabilities using its short-term assets.

Formula:

Current Ratio = Current Segments/ Current Liabilities

Interpretation:

Equal to 1:

The firm’s assets are equal to liabilities and therefore all current liabilities have an equivalent amount of current assets.

Greater than one:

The firm has more current assets than current liabilities and is therefore regarded as having good liquidity.

Less than one:

The firm is perceived to have possible liquidity issues which means the entity cannot meet its short-term obligations.

Example:

ITC current ratio has exceeded one alongside D MART and V MART, demonstrating that these firms can smoothly liquidate assets in exchange for settling liabilities.

Negative working capital is utilized by Maruti, Mahindra and HUL, meaning they rely on the trust of their suppliers and customers to maintain operations.

Cash Ratio

Definition: The cash ratio measures how easily the company can pay off its current liabilities by accessing its cash reserves.

Formula:

Cash Ratio = Cash / Current Liabilities

Interpretation:

• Cash ratios above 1 imply that a business is holding onto ample cash to cover its liabilities.
• Cash ratios that are too high may indicate that the company is not effectively managing its cash or is underinvested in growth.
• Principles for Effective Cash Management
• Proper cash flow management is more than just keeping track; it entails planning and discipline. Here are some essential principles of effective cash management:

Paying Invoices and Bills on Time

Setting specific days for making payments allows businesses to better organize their outflows and aids in making timely payments to their vendors. This strengthens the relationships with those suppliers while improving cash flow management.

 Understanding The Nature of Cash

Understanding the distinction between cash as a source of earning (revenue) and cash as an obligation (debt) is critical. Making incorrect assumptions about these distinctions can create a convoluted cash flow.

 Cash Flow Predictions

Good cash flow management begins with proper planning. It involves projecting the expected revenue and liabilities for the upcoming quarters. This step logistically enables prediction of cash shortages and provides for necessary planning for funding.

 Daily Reconciliation

You should track the closing balance at the end of each day, week, and month. Reasonable tracking improves the cash position which grants better decision making and expense control.

Solutions for Cash Shortages

Strategic solutions are required to prevent business disruption and ensure operational continuity during cash flow tight situations. Here are some tried and tested solutions:

Trade

Instead of paying cash, rather than utilizing bartering, goods or services can be traded with suppliers instead. This facilitates maintaining relationships and allows to do away with immediate cashflow.

 Expense Management

Avoiding unnecessary business spending can be somewhat of a cash booster. Focus on cutting down on anything operational that can be done at reduced costs without sacrificing quality or service.

 OPEX over CAPEX

There is greater flexibility with vague operational expenses (OPEX) compared to spending capital (CAPEX). Once the effectiveness and necessity of upfront purchases is evaluated, consider changing the capital spending to operating expenses when possible.

 Reuse

Inexpensive refurbished items such as phones or laptops can be purchased and still serve business function meaning great value for money.

Outsourcing

Outsourcing non-core activities will help with budget reduction. Lowers Operational expenses gives you opportunity to direct finances to other important business sectors.

Implement Audit Systems

Regular audits serve more than just statutory obligations, they serve as a means to detect any operational discrepancies or deficiencies and provide a means to rectify them. Instituting an audit system improves the efficiency of cash flow management.

Create a Rainy Day Fund

Reserve funds are essential during an unmatched financial crisis. These funds should be kept aside of the main cash reserve operating funds so that they yield no expenditure during unmatched circumstances.

What Not to Do with Your Bank Balance

Having cash on hand is highly beneficial, but there are certain things you must avoid doing. Here is a list of things not to do with the business bank balance.

Avoid Betting:

Steer clear of spending any business capital towards gambling.

Avoid Stock Market Investments:

Gilts and Unit Trusts are always a better and safer option for corporations because they do not allow cash to flow freely.

Consider Safe Investments:

Cash can be kept in low yielding liquid mutual funds to avoid any risk to spare funds.

Massive Action Plan for Cash Management

After forming this whole system, you can manage cash in your business effectively. Here’s a comprehensive list of steps in a single framework to help you achieve best cash management results.

Evaluate Your Daily Cash Position:

Every now and then check the cash balance in your business bank account to gauge your liquidity position.

Execute the 7-Step Framework:

Apply the aforementioned methods and principles to improve cash management.

Review Investments:

Look over high-risk investment portfolios like stocks to make sure that they are correctly funded.

Learn from Large Companies:

Analyze how well-established firms utilize their trust with both suppliers and customers to meet their cash flow needs and sustain their business operations.

Conclusion

Strategic cash management is critical to company liquidity and insures business success over time. Understanding and using major financial ratios, managing cash flow, and devising cash crunch solutions arms businesses against financial adversities. Adjustments to cash management policies should be made on an ongoing basis based on new information, ensuring a company’s financial position is always ready to create growth.

Categories: Working Capital Management