Top 2 Strategies of Cash Management | Working Capital

Posted on 28th Jun 2019

The following points highlight the top two strategies of cash management to deal with various facets of cash.

Article shared by : Anjay Kumar

Cash Management Strategy # 1. Cash Planning:

Cash planning is a technique to plan and control the use of cash. A projected cash flow statement may be prepared, based on the present business operations and anticipated future activities. The cash inflows from various sources may be anticipated and cash outflows will determine the possible uses of cash.

Cash Management Strategy # 2. Cash Forecasts and Budgeting:

A cash budget is the most important device for the control of receipts and payments of cash. A cash budget is an estimate of cash receipts and disbursements during a future period of time. It is an analysis of flow of cash in a business over a future, short or long period of time. It is a forecast of expected cash intake and outlay.

The short-term forecasts can be made with the help of cash flow projections. The finance manager will make estimates of likely receipts in the near future and the expected disbursements in that period. Though it is not possible to make exact forecasts even then estimates of cash flows will enable the planners to make arrangement for cash needs.

It may so happen that expected cash receipts may fall short or payments may exceed estimates. A financial manager should keep in mind the sources from where he will meet short-term needs. He should also plan for productive use of surplus cash for short periods.

The long-term cash forecasts are also essential for proper cash planning. These estimates may be for three, four, five or more years. Long-term forecasts indicate company’s future financial needs for working capital, capital projects, etc.

Both short-term and long-term cash forecasts may be made with the help of following methods:

(i) Receipts and disbursements method

(ii) Adjusted net income method.

(i) Receipts and Disbursements Method:

In this method the receipts and payments of cash are estimated. The cash receipts may be from cash sales, collections from debtors, sale of fixed assets, receipts of dividend or other incomes of all the items; it is difficult to forecast sales. The sales may be on cash as well as credit basis. Cash sales will bring receipts at the time of sale while credit sales will bring cash later on.

The collections from debtors (credit sales) will depend upon the credit policy of the firm. Any fluctuation in sales will disturb the receipts of cash. Payments may be made for cash purchases, to creditors for goods, purchase of fixed assets, for meeting operating expenses such as wage bill, rent, rates, taxes or other usual expenses, dividend to shareholders etc.

The receipts and disbursements are to be equaled over a short as well as long periods. Any shortfall in receipts will have to be met from banks or other sources. Similarly, surplus cash may be invested in risk free marketable securities.

It may be easy to make estimates for payments but cash receipts may not be accurately made. The payments are to be made by outsiders, so there may be some problem in finding out the exact receipts at a particular period. Because of uncertainty, the reliability of this method may be reduced.

(ii) Adjusted Net Income Method:

This method may also be known as sources and uses approach. It generally has three sections: sources of cash, uses of cash and adjusted cash balance. The adjusted net income method helps in projecting the company’s need for cash at some future date and to see whether the company will be able to generate sufficient cash.

If not, then it will have to decide about borrowing or issuing shares, etc. In preparing its statement the items like net income, depreciation, dividends, taxes, etc. can easily be determined from company’s annual operating budget.

The estimation of working capital movement becomes difficult because items like receivables and inventories are influenced by factors such as fluctuations in raw material costs, changing demand for company’s products and likely delays in collections. This method helps in keeping a control on working capital and anticipating financial requirements.