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What Is Cash Flow? 4 Cash Management Tactics

March 3, 2013

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One of the first things you should learn about finance is what is cash flow. Managing for cash flow is concentrating your attention on a scarce, essential resource.

Cash flow is the focus of much of the public discussion of financial issues.

Here are four tactics for good cash flow management:

  1. Collect it as quickly as you can.
  2. Hold it as long as you can.
  3. Release it as slowly as you can.
  4. Have little or none on hand.

 

This last line probably needs a little explanation. If you decide to maintain a specific cash balance, you are, in effect, saying that you do not want to use that cash. You pay your bills from the cash flow that you have—your income—and if you do not have enough cash to pay those bills, you arrange to borrow the needed funds. Although the cash you hold provides personal comfort, it earns you little or nothing—particularly when interest rates are low. Therefore, if you have cash flow and access to cash when you need it, you need not hold any cash on hand. This is also true for a business, especially since the cash held really belongs to the shareholders. If it earns them little or nothing, it is not really beneficial.

Often cash management also requires managing the relationship between the company and its bank. This is so that necessary financing and bank services will be available. You also need to manage risk so that the company is insured for casualty losses and investment management to assure that the company earns a proper return on its excess cash.

The idea that we should have little or no cash probably seems alien to you.

A business holds cash (whether in currency or in a checking account) to engage in transactions. However, cash held earns little or no interest.

Therefore, the prudent manager would prefer to invest the cash where it will earn a greater return. The manager can’t invest or use too much of the cash, however, or the business will not have enough on hand to make purchases, pay bills, pay salaries, or pay taxes. The business must find just the right amount of cash to keep on hand. This is not as hard as it sounds, because most people and most businesses have predictable, and reasonably consistent, cash flows. It is not necessary to hold large amounts of cash because the account at the bank is being replenished continuously. So begin managing your cash flow by figuring out how much cash you need on hand for your basic costs.

 Adapted from Finance and Accounting for Nonfinancial Managers, Third Edition, by Eliot H. Sherman.

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About The Author

Eliot H. Sherman, CPA, has more than twenty-five years of financial management experience. He is currently a full-time Senior Lecturer in the Finance and Insurance Department of Northeastern University’s College of Business Administration. He is also a part-time Professor of Finance at the Hult International Business School and an Adjunct Professor at Brandeis University.

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