Cash Management

Introduction

One of the most critical functions of a firm’s accounting manager is that of cash management. Unlike long-term forecasting or choosing to expand a company’s fixed assets, cash management requires constant, immediate, and responsive decision-making. There is no opportunity to carefully consider each possibility and wait to further observe trends within the market. Inventory and demand for cash change daily, therefore, the accounting manager must be well-versed in the most effective ways to manage the cash a firm has, along with the most efficient ways to obtain cash as needed. This paper will compare and contrast various cash management techniques, as well as compare and contrast the various methods of short-term financing.

Cash Management Techniques

Most people are often taught conservative cash management practices, but most companies do not want to keep any more cash on hand than absolutely necessary. Most companies must keep some cash for transactions, bank payments, and potential emergencies; the opportunity cost of holding an excess of cash rather than reinvesting it into current assets or growing the firm’s fixed assets is often significant. There are multiple techniques that a firm can employ to manage its cash. Some of these techniques include float, short-term investments, and international cash management.

Float

Due to the opportunity cost of holding excess cash, most companies try to leverage the minimal amount of cash that they carry to cover as many payables as possible. One way that firms achieve this goal is by employing the use of float. Float refers to the difference between the balance carried on the corporate books and the amount credited to the corporation by its bank (Block & Hirt, 2005). Payables and receivables are entered into corporate books as processed; however, the actual transactions will not be recorded by the bank until the payment has been received and processed by a company and later processed by the bank. Companies frequently work to take advantage of this opportunity to use their cash up until it is claimed by the recipient’s bank by improving collections and extending disbursements. In short, the more efficiently a firm can collect on its receivables and the more time it can take in paying its own bills, the lower the firm’s cash requirements for payments will be. While some companies take this to the extreme of consistently operating with a negative cash balance in their books, they must be aware of the risk of being caught without cash in unforeseen circumstances or upon the start of a tight money cycle. Health Management Organizations (HMO) are an example of an industry that is maximizing its cash retention by employing the use of the float. A reknowned Princeton University healthcare economist Uwe Reinhardt comments, “[A] big HMO . . .could pocket more than $400,000 a day by collecting on the float” (Scott, 1997, p.28). In 1997, the fastest HMO payment cycles were more than 40 days, while the slowest quarters averaged 89.5 days (Scott, 1997). By holding onto their cash for as long as possible, these insurance organizations are able to minimize their need for cash. Unfortunately, the HMO floating practices are negatively impacting healthcare providers, putting them into a tighter cash flow situation in which they must carry more cash to cover for the lack of receivables paid by the HMOs.

Short-Term Investment

While some very aggressive companies carry negative cash balances by utilizing the float, more conservative companies may hold excess funds when anticipating a cash outlay. While these funds are being held, they should be converted from cash to more profitable interest-earning marketable securities (Block & Hirt, 2005). There is a wide range of securities from which to choose; the accounting manager should consider yield, maturity, minimum investment required, safety, and marketability when selecting a security (Block & Hirt, 2005). As a rule, the longer a security’s maturity period, the higher return it will yield. However, as with any cash management decision, there is risk to consider. If interest rates dramatically increase during the security’s maturity period, the company’s cash may be tied up when it has the opportunity to purchase higher-yielding securities resulting from the increased interest rates.

Types of Short-Term Investments

Banking savings accounts, money-market funds, certificates of deposit (CD’s) and treasury bill(T-Bills) can be classified as short-term investments. These investments are relatively safe because they are guaranteed by the government and they typically mature over a short period of time.There is also a downside to short-term investment because they generally will pay a low interest rate from 3 to5 percent; in addition they may lose value after adjustments for inflation.

International Cash Management

While the float stretches cash on hand by delaying payables and increasing speed of receivables, and short-term investments attempt to maximize the cash on hand in various ways; international cash management takes advantage of today’s global economy. Companies may opt to hold cash balances in a particular currency because it has a strong exchange rate in comparison to the company’s home currency. Likewise, an accounting manager may seek out a country with high interest rates to apply the company’s cash to short-term investments in those countries. For example, an American company may choose to hold its cash reserves in the Euro or English pound because these currencies and interest rates are stronger than the dollar. Table 1 illustrates historical and forecast short-term interest rates in five countries (National Institute Economic Review, 2006, p. 14). Viewing this table, it is easy to understand why a Japanese company may opt to invest its cash reserves in short-term investments in the United Kingdom to quickly increase the value of that cash. Like the float, while this practice may benefit a company, the accounting manager should fully assess the risk of international investing, considering such factors as the volatility of a country’s economy and government, along with any ethical concerns that may arise from cultural differences between countries and how they are viewed by potential investors.

Table 1 Short-Term Interest Rates 2003-2008

USA Canada Japan Euro UK