This article is by Randy S. Miller, Partner, CFO Edge, LLC.
There are many reasons why a business becomes successful, but nothing can have a greater negative impact on a business than not managing cash effectively.
For many businesses, the process of effective cash management becomes a cumbersome and haphazard process driven by the needs of the moment. In order to avoid this situation, businesses need to develop a cash management plan.
Cash management involves understanding the business’s cash flow, knowing when to seek extra cash infusions and knowing when you have excess cash how to effectively invest it.
Defining your cash flow cycle and understanding the difference between cash flow and profits is the first step in cash management. Companies in growth mode may be profitable, but because growth often requires investment in operations and equipment, cash is short. Once a company defines the sources and uses of its cash, it can be begin the process of planning for cash needs. (For further reading: Understanding Your Cash Flow Cycle and What’s the Difference Between Profits and Cash Flow?)
This planning process includes determining why the company needs cash – working capital, expansion, or acquisitions, and how it will acquire the cash necessary to grow. Options include selling equity, or financing. If it is determined that financing is the preferable method of cash acquisition, there are five main types of business financing available: lines of credit; term loans, commercial mortgages; leasing; and government loan programs. (For further reading: The Primary Types of Business Loans)
With the development of an effective cash management program, a company may find that it is generating free cash flow. If it is determined that this cash is not just a timing function, the company has the opportunity to invest this cash and increase its returns while still protecting the capital. At this point, the company needs to evaluate the safety, liquidity and returns of various investments to determine the appropriate allocations. (For further reading: Guidelines for Investing Excess Business Cash)
The partners at CFO Edge represent decades of experience in helping companies build effective cash management plans. And we bring an independent and balanced viewpoint to assist your company or client in developing an effective cash management plan.