The strategy for effective cash management in any firm has a core component of ensuring an uninterrupted supply of cash to the operating cycle. This cash is ideally generated from the cycle itself but under certain circumstances infusion of cash from outside the cycle also takes place. Examples of such circumstances are:
- when the firm has been newly set up and the cycle has yet to commence;
- when due to disruption in the cycle, cash gets stuck in other current assets, and outside cash infusion in the form of promoters lenders’ contribution is done.
Essential elements of a successful cash management strategy are:-
– Realistic cash forecasting
– Speeding up collections
– Spreading out payments
(1) Realistic cash forecasting
By realistic cash forecasting, we mean that a cash forecast for the entire next year should be prepared at its commencement. The cash forecast has two parts—one is the forecast of cash flows from the operating cycle and the second part is the capital flows. The first part originates from the sales forecast for the year while the second part originates from the capital budget. The surplus of cash generated from the operating cycle is called the internal accruals of the firm and it is used to fund the capital outlays together with bank borrowings.
For a realistic cash forecast, the sales projections and capital budget have to be drawn up after extensive deliberations in the management committee of the firm. Such a forecast carries a cushion for normal contingencies like sudden spurt or shrinkage in demand for which mid-term modifications in the forecast are made. The involvement of operational level people, both from production and sales areas, is essential for a realistic cash forecast.
(2) Speeding up Collections
After the cash forecast has been prepared, the firm should ensure that in day to day operations cash (including cheques) should be collected speedily. Towards this end, a schedule of receivables should be prepared and kept updated. Before the due date of each payment, the debtor should be reminded of it. When the cheques are received on due dates, these should be credited to the bank account expeditiously. For a multi-locational firm, arrangements should be made with the bank for the on-line transfer of funds to the main account. Similarly, facilities like drop boxes can be provided by firms having a large user base whereby customers can drop their payments in boxes placed at vantage locations.
(3) Spreading out Payments
Simultaneously with speeding up the collection, the firm should spread out payments as far as possible. It means that if the credit period is available in some payments, it should be utilized fully. Bunching of payments should be avoided. For outstation customers, arrangements can be made with the bank for making at par payment.