Cash is the most liquid asset in any business across the segment and stage. Specially in a start-up or a SME business, the capital trapped with the clients kills the business growth and many a time Business itself goes for toss. Appropriate cash balance makes you fly or even crash if mishandled. We all know that cash is needed for monetary transactions and taking care of any immediate or contingent need, but it has its own opportunity cost too.
So the business should make a plan and estimate the receipts and payments for the future period for maintaining optimal utilization of such liquid resources. A high cash level does not necessarily mean an optimum level.
The optimal cash level is the break-even point between the transaction cost and opportunity cost. The basic principles of optimal cash management are as follows:
- Adopt a good cash forecasting and estimation system
- Initiate simple and periodical cash reports
- Do not allow idle cash at any point in time
- Collect as fast as possible even at the cost of cash discounts
- Maintain a healthy relationship with bankers
- Modernize the receipt and payment mechanics
- Develop and use the short term borrowings
Cash forecasting is one of the major tools of cash management, and it includes making of policies towards the preservation and estimation of inflow and outflow. This may include the cash requirements for a specified period, short-term financing, scheduling of outward payments, purchases of raw material, cash credits and employees petty cash payments. This is also called a cash flow statement. While estimating the fund flow and bringing discipline in the company, this method of forecasting does not take into account the uncertainty caused by third parties like vendors or clients. In short, no probability wisdom is used here, therefore at times, it cannot be considered to be the most reliable forecast even though it is widely used.Cash reports provide a variance statement of the actual cash flow as compared to the forecasted one and are helpful in controlling and revising/rescheduling the fund flows to adapt to the scenario change. In general, we adopt the following three such reports in our management information system (MIS):
a. Daily cash statement
b. Weekly cash reports
c. Monthly cash summary
The following are the options where one can park their idle money:
- Money multiplier accounts where the balances are made term deposits and are utilized as and when the fund is needed leaving the unused part to continue to earn interest. This is something that should be done by all businesses and, in particular, all the funded Start-ups to have some financial income too
- Overdraft against fixed deposits also provides a tool for saving and many bankers offer this
- Stock market liquid funds and arbitrage funds
- Discount earnings wherein you may offer to the vendor to pay before the due date against some cash discounts. This helps maintain a better operating profit
Collect as fast as possible Collecting fast in any business plays a crucial role in the sustenance of business in the short as well as long run. A collection strategy is an important tool towards cash and liquidity management, and it talks about the discipline an organization maintains.
Few important factors which have a long-drawn impact on the success of such strategies are as follows:
- Restrictive credit benchmarks
- Tracking system for due dates and strict protocol for overdue payments
- Avoid extended credit terms and build a cash discount in pricing strategy
- Have a model of advance payments or midway billings, than arrears
- Base all business incentives on collection rather than billings
- Keep the line of steps to be taken on overdue payments simple and fluid for the collection manager
- Do not hesitate much on legal recourse as the client who does not pay rightly is not a good client
A banking relationship is a crucial business relationship for all sizes of business and specifically for SME. Modernize the receipts and payments process Even though the cheque clearing system continues to exist, there has been an upsurge in the digital payment system and the same should be adopted wherever possible. This helps you to reduce the float in your business and be more liquid at any given point of time. The usability of your money gets enhanced and collection time reduces. If opted well, the collection cycle can simply be reduced by three days and creditors’ payments too can be optimized for saving three days. I also suggest having a credit line with any bank or financial institution on an ongoing basis irrespective of the present need. The products like invoice factoring, bill discounting and overdraft facility to finance your receivables must be there, on as and when needed basis. Your rightful money should be timely available for your business, and it should not be dependent upon someone else’s decision, situation and capacity.