What are the Objectives of Cash Management?

One of the main objectives of cash management is ensuring that a business always has enough money available to pay for what it needs in the present and near future. It is important to keep an eye on the money that is coming in and going out so the business does not undergo a shortage of cash when it is needed.

Table of Contents

• Objectives of Cash Management
• Types of Cash Management Explained with Examples
• Advantages

Cash management is about how a business handles its money. It includes all the means through which a company gets, spends, saves, and manages its money to make sure it can pay for things it needs now and in the future. 

Objectives of Cash Management

Cash management has the following objectives due to which it is performed:

1. Ensuring Sufficient Liquidity: The main goal here is to make sure a business always has enough money available to pay for what it needs right away and in the near future. Through cash management, businesses can monitor the money coming in and going out so the business does not run into trouble by not having enough cash when it is needed.
2. Minimizing Borrowing Costs: When a business manages its money wisely, it can avoid borrowing too much or borrow in a smarter way. This is an important objective of cash management since borrowing money costs extra in the form of interest. By needing to borrow less or by choosing the best times and ways to borrow, a business can spend less on these extra costs, which helps it stay in better financial shape.
3. Optimizing the Return on Investments: Another important objective of cash management is to put money to work. This means investing surplus cash in such a way that it earns the highest possible return while keeping risk at an acceptable level. This could involve short-term investments that are easy to convert back into cash when needed.
4. Strengthening the Financial Position: Effective cash management helps a business maintain a strong financial position. This means that the company the ability to meet unexpected expenses and leverage investment opportunities quickly. One of the objectives of cash management is company becoming capable to negotiate better terms with suppliers and creditors due to its strong cash standing.
5. Reducing the Cost of Capital: By efficiently managing cash and demonstrating a strong liquidity position, a business can improve its credit rating. A good credit rating leads to lower rate of interest on borrowed funds. This helps in reducing the company's cost of capital. This makes investments more affordable and can significantly enhance profitability.
6. Enhancing Operational Efficiency: Proper cash management involves streamlining processes related to receivables and payables, which can lead to more efficient operations. For example, automating invoice processing and payments can reduce costs, minimize errors, and speed up cash cycles.
7. Preparing for Uncertainty: A key objective of cash management is to prepare the business for uncertain financial environments. This involves maintaining adequate reserves to handle economic downturns, market volatility, or unexpected challenges without needing to resort to emergency financing.
8. Maximizing Payment Terms: Effective cash management also means strategically managing when to pay suppliers to benefit the company's cash flow without damaging relationships. This might involve negotiating longer payment terms with suppliers to keep cash in the business longer.

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Types of Cash Management Explained with Examples

The following types of cash management are used by companies for running their business smoothly with a different purpose in each type:

1. Cash Flow from Operating Activities

This represents the cash a company generates from its regular business operations. It excludes income from investments or financing activities. This reflects how well the company can produce cash from its core business operations.

A bakery sells bread, cakes, and pastries. The cash it receives from customers for these goods, minus the cash it spends on ingredients, rent, utilities, and employee salaries, represents its cash flow from operating activities. If the bakery makes ₹100,000 in sales and spends ₹60,000 on these expenses, its cash flow from operating activities is ₹40,000.

2. Free Cash Flow to Equity (FCFE)

FCFE refers to the amount of cash available to the company’s equity shareholders after all operating expenses, interest, and principal payments are made, and investments in the working capital as well as fixed assets are covered. It indicates a company's ability to generate cash that can be distributed to its shareholders or reinvested.

Continuing with the bakery example, suppose it has a cash flow from the operating activities of ₹40,000. If it spends ₹10,000 on loan repayments and ₹5,000 on maintaining or replacing kitchen equipment, the bakery's FCFE is ₹25,000. This is the cash that could potentially be distributed to the owners or reinvested into the business.

3. Free Cash Flow to the Firm (FCFF)

FCFF refers to the cash flow available to all of the company’s security holders, including both debt and equity. It is calculated before any cash payouts to lenders or shareholders and represents the total value generated by the company that will be probably allocated to debt and equity holders.

If the bakery generates ₹40,000 from its operations and needs to reinvest ₹5,000 in kitchen equipment but has no debt repayments (assuming it's debt-free for this example), its FCFF is ₹35,000. This amount is available to be either reinvested into the business or distributed to the owners.

4. Net Change in Cash

This is the total change in a company's cash and cash equivalents from one period to the next, reflecting all cash inflows and outflows from operating, investing, and financing activities.

• At the beginning of the year, the bakery has ₹10,000 in cash.
• Throughout the year, it generates ₹40,000 in cash from operating activities.
• It spends ₹5,000 on new kitchen equipment (investing activity), and pays out ₹10,000 in loan repayments.
• The net change in cash for the year is ₹25,000 (₹40,000 - ₹5,000 - ₹10,000).
• The bakery's total cash and cash equivalents at the end of the year will be ₹35,000 (₹10,000 + ₹25,000).

Advantages of Cash Management 

The following are the advantages of cash management:

• Liquidity Maintenance: Cash management ensures that there is sufficient availability of funds to meet immediate and short-term obligations, safeguarding against liquidity crises.
• Cost Reduction: Through effective cash management, the need for external financing and its associated costs is less.
• Cash Flow Optimization: It balances cash inflows and outflows through precise planning and financial forecasting. This is essential for uninterrupted business operations.
• Investment Income: Cash management allows for the strategic investment of surplus funds in short-term, low-risk financial instruments, generating additional revenue.
• Financial Health Improvement: It boosts profitability and return on investments by efficiently allocating and utilizing available cash resources.
• Credit Standing Enhancement: With effective cash management, the credit profile of a business or individual improves. This facilitates easier access to credit and better borrowing terms.
• Risk Management: Cash management helps in mitigating financial risks by ensuring adequate liquidity to cover unexpected expenses or downturns in revenue.
• Strategic Growth Support: Provides the financial flexibility to capitalize on growth opportunities, such as expansions or acquisitions, without relying on external funding.
• Operational Efficiency: Streamlines payment processes and improves the management of receivables and payables, reducing transaction costs and delays.
• Financial Discipline Promotion: Encourages fair and less risky financial management practices. This helps in making more informed investment decisions.
• Market Competitiveness: Enhances the ability to quickly respond to market opportunities and competitive challenges, securing a stronger market position.

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