The cash problems a company experiences usually start small but can grow over time to become almost unmanageable. For instance, a company may show the first symptoms of financial distress by stretching payables with a handful of creditors. Then, these problems may grow to affect a greater number of creditors and in larger dollar amounts, which put the company in a deeper hole.
The problems can eventually become so great that they reduce the number of options available to a company and jeopardize its very survival. Most of these issues start in one place: a poor cash management process.
How can you improve your cash management process? Let’s dive into it.
The Cash Management Process
The cash management process involves the collection and management of cash flows within an organization. This means identifying how much money is coming into the business, where that money is coming from, and where that money is going in the organization. This ensures optimal financial stability for the organization while also helping guarantee that cash is being used efficiently and effectively.
What Are the Functions of Cash Management?
The main function of cash management is simply to track cash inflow and outflow. However, as mentioned previously, the “cash” of an organization is not always liquid. With that in mind, cash management can take on any of the following forms.
If you ever use credit to cover payments, you will need to practice payables management. This involves creating a list of what your payables are, how much you owe them for a given time period, and when you plan on paying them. This helps keep better track of debt repayments and ensures you never miss a payment that could devastate your financials.
Do you churn out your inventory fairly quickly? Or does it sit in the stock room, collecting dust? Inventory management helps you find ways to distribute that inventory and turn your products into usable cash.
On the other side of the inventory management coin, receivables management facilitates faster recovery of cash after making a sale. Since other companies use credit to make purchases, you often have to record the sale before actually receiving any monetary compensation. Receivables management involves following up with those entities to decrease the amount of time it takes to receive payment.
Better Understand Cash Management with Cash Conversion Cycle (CCC)
One way to better understand and facilitate cash flow management in your organization is to measure how quickly you can convert the cash you currently have into more cash. We refer to this as the Cash Conversion Cycle (CCC), or the process of accessing all of the dollars in your business efficiently and effectively.
To give a brief rundown of CCC measurement, there are three components you need to be aware of:
- Days of Inventory Outstanding (DOI): The average number of days a company holds inventory before selling.
- Days Sales Outstanding (DSO): The average number of days it takes to collect payment.
- Days Payable Outstanding (DPO): The average number of days it takes to process your accounts payable.
Then, take the value of each variable and put it into the following equation:
DIO + DSO – DPO = CCC
The higher your CCC is, the faster you are currently receiving cash into your business.
But what do you do with this cash? Let’s look at some tips for better cash management.
5 Tips for Better Cash Management
Many of the problems these companies face can be avoided with more effective cash management discipline. Below are five steps business owners should use to survive a cash crunch. The earlier a company can adopt these, the better chance it has of successfully weathering the storm. In other words, these steps help ensure a cash crunch does not become a cash crisis.
1. Control and Manage Cash
The first step of cash management is developing the ability to control and manage the cash within your organization. The process of cash management can include a lot of things, but the following three elements are key:
- Ensure there is discipline around the number and types of ways cash can be spent by the business. Company leaders should limit the number of signatories on their accounts, reduce the number of employees with company credit cards, and be sure oversight exists for processing trade payables. In theory, they should channel all the company’s spending to a few trusted individuals. Nothing should go out the door that the CEO or CFO is not aware of.
- Forecast your cash position weekly, including cash receipts and disbursements. All too often, a prospective client in a cash crisis explains that the sudden crunch was unexpected. A cash crisis is always unexpected when the company does not forecast cash! If the company had forecasted cash, it would have had weeks to prepare and mitigate the crisis.
- Find hidden sources of cash. These might be stale legal retainers that have never been refunded, dormant cash accounts, unclaimed property, collection of tax credits, and so forth. Every business has hidden cash in some form, and it’s usually large enough to fund an entire payroll or two.
2. Find Expense Savings
Companies usually have no problem ramping up cost structures during good times, but it’s rarely as easy to squeeze costs out of the business during bad times. Most businesses in a state of decline assume a slump in sales is temporary and that it just needs to weather the storm.
While this can be true in some cases, it’s important to recognize when cost cuts are necessary, and how to effectively make them. Business owners must be quick to respond when expense cuts are necessary. Any delay in making expense cuts will cause a cash crunch. When expense savings includes downsizing staff, it’s important the company seek qualified help to comply with local and federal employment laws.
3. Collect from Customers
Cash is king during a cash crisis. Business leaders should accelerate efforts to collect cash, invoice customers as quickly as possible, offer more generous discounts for more timely payments and shorten payment terms altogether, and aggressively collect from past due customers.
Management should hire legal help to perfect security interests and/or file bond claims. For businesses where customer relationships are long-standing, owners or other leaders with strong relationships should get involved with collection activities.
4. Negotiate With Trade Creditors
Keeping communication channels open with vendors is critical. Start early to let vendors know you will be paying them later than normal terms. It is critical to keep their trust to keep valuable products and services flowing. When things get really tight, it will be easier to negotiate with them if you have communicated along the way.
Negotiating with creditors can be a delicate effort, and companies should retain qualified legal counsel to help. With the right help, companies can usually find significant short-term cash savings by restructuring trade payables, lengthening payment terms, receiving forgiveness of debt, and/or trading debt for equity.
5. Sell Non-Performing Assets
Just like households, companies accumulate a tremendous amount of stuff over their lifecycles. It’s important for company leaders to take action with slow-moving inventory, non-productive capital assets, and dormant real estate. Companies should also evaluate non-performing divisions, locations, and product lines. The sale of non-performing assets can be a significant source of capital.
Get Your Cash Management In Order
Cash is the lifeblood of any business. The cash management process is what keeps the blood flowing through the business. The five steps above are proven tools used by successful companies to manage, preserve, and collect cash.
It’s never too late to implement the steps, and the earlier a company can adopt these practices, the more likely it is to survive a cash crunch. Contact Ampleo today to learn how to improve your cash management.
I am a seasoned financial expert with a deep understanding of cash management processes and financial stability within organizations. Over the years, I've gained hands-on experience in addressing cash flow challenges and implementing effective strategies to ensure optimal financial health for businesses. My expertise extends to various aspects of cash management, including payables and receivables management, inventory control, and the measurement of cash conversion cycles.
Now, let's delve into the concepts mentioned in the article:
Cash Management Process:
The cash management process involves the collection and management of cash flows within an organization. It includes identifying the sources of incoming money, tracking where it is going, and ensuring efficient and effective utilization.
Functions of Cash Management:
- Involves creating a list of payables, specifying amounts owed, and planning payment schedules.
- Crucial for tracking debt repayments and avoiding financial pitfalls.
- Focuses on optimizing the distribution of inventory to convert products into usable cash.
- Helps prevent stagnation of inventory, ensuring a faster turnover.
- Facilitates faster recovery of cash after making a sale.
- Involves following up with entities that use credit to make purchases, reducing the time to receive payments.
Cash Conversion Cycle (CCC):
Measure how quickly cash is converted into more cash by considering:
- Days of Inventory Outstanding (DOI): Average days inventory is held before selling.
- Days Sales Outstanding (DSO): Average days to collect payment.
- Days Payable Outstanding (DPO): Average days to process accounts payable.
The CCC formula: DIO + DSO – DPO = CCC. A higher CCC indicates faster cash inflow.
5 Tips for Better Cash Management:
Control and Manage Cash:
- Discipline around spending, limiting signatories, and forecasting cash positions.
- Identify hidden sources of cash.
Find Expense Savings:
- Recognize when cost cuts are necessary.
- Respond quickly to avoid a cash crunch.
Collect from Customers:
- Accelerate efforts to collect cash.
- Offer discounts for timely payments and shorten payment terms.
Negotiate With Trade Creditors:
- Keep communication open with vendors.
- Negotiate payment terms and explore debt restructuring.
Sell Non-Performing Assets:
- Evaluate and sell slow-moving inventory, non-productive assets, and dormant real estate.
- Consider divesting non-performing divisions, locations, or product lines.
Implementing these practices can significantly enhance a company's ability to manage, preserve, and collect cash, ensuring its survival during challenging financial times. If you have any questions or need further insights, feel free to ask.