What is cash management?
Cash management is the set of practices an individual or company uses to monitor, collect, hold and deploy cash. For businesses it is typically run by treasurers, finance managers or the chief financial officer (CFO). For individuals it can mean keeping enough liquid balances to pay bills while placing extra cash in short-term, interest-bearing accounts. The goal is to make sure obligations are met when due while maximizing the return and flexibility of liquid funds.
Key components and definitions
– Cash flow statement: a financial report split into operating, investing and financing activities that shows cash inflows and outflows over a period. The bottom-line figure is the change in a company’s available cash.
– Working capital: current assets minus current liabilities. A quick measure of short-term financial cushion.
– Accounts receivable (AR): amounts customers owe that will convert to cash, typically within a year.
– Accounts payable (AP): amounts the company owes suppliers and others in the short term.
– Cash management account: a type of retail financial account that consolidates checking, savings and brokerage cash functions; often offered by banks and broker-dealers.
– Liquidity: the ability to meet near-term obligations.
– Solvency: the ability to meet obligations over the long term.
Why cash management matters
– It ensures bills and payroll can be paid on time.
– It reduces the chance of forced borrowing at high rates.
– It enables deployment of excess cash into short-term investments or debt reduction.
– It supports accurate internal and external financial reporting and compliance (for public companies, internal controls and legal accountability are reinforced by regulations such as the Sarbanes‑Oxley Act).
Cash-management tools and solutions
– Bank services: zero-balance accounts, automated sweeps (credit sweeps) that move excess balances to pay down lines of credit or into higher-yield accounts.
– Short-term investments: money market accounts, Treasury bills, and other highly liquid instruments.
– Treasury management services: lockbox collections, incoming-payment processing, and payables automation.
– Cash management accounts at broker-dealers or banks that centralize deposits, payments and short-term investing.
Internal controls and reporting
Companies use accounting controls and audit procedures to prevent errors or misuse of cash and to ensure accurate reporting. The cash flow statement is monitored regularly (often daily internally and quarterly for public reporting). Management has legal responsibility for accurate financial statements under applicable laws such as Sarbanes‑Oxley.
Key ratios (with formulas)
– Working capital = Current assets − Current liabilities
– Current ratio = Current assets / Current liabilities
– Quick ratio (acid-test) = (Cash + Marketable securities + Accounts receivable) / Current liabilities
Are cash-management accounts insured?
Protection depends on the product and provider. Bank deposit accounts are generally protected by the Federal Deposit Insurance Corporation (FDIC) up to insurance limits. Accounts held at broker-dealers are typically covered by the Securities Investor Protection Corporation (SIPC) for certain losses related to brokerage failure (not against market losses). Check the provider and product for exact protection details.
Improving AR and AP flows: practical steps
For accounts receivable (speed cash collection)
– Invoice promptly and clearly.
– Offer electronic invoicing and multiple payment channels (ACH, card, bank transfer).
– Provide early‑payment discounts (e.g., 2% if paid within 10 days).
– Use automated reminders and collections workflows.
For accounts payable (optimize timing and cost)
– Take full advantage of agreed payment terms.
– Use automated bill payment and virtual cards to maximize rebate programs.
– Negotiate longer terms where appropriate without harming supplier relationships.
– Consolidate suppliers to reduce processing costs.
Short checklist — daily to quarterly
Daily
– Reconcile bank balances to expected collections and disbursements.
– Monitor short-term borrowing lines and available liquidity.
Weekly
– Update forecast for next 30–90 days.
– Process electronic collections and approve high-value payments.
Monthly
– Reconcile cash and AR
and AP; review bank fees and merchant costs; update the 30–90 day forecast; analyze variances against budget; and refresh working‑capital KPIs.
Quarterly
– Review and stress‑test the 13‑week cash forecast under at least three scenarios (base, downside, upside).
– Reconcile bank accounts, sweep/zero‑balance accounts and intercompany balances.
– Review available credit lines, covenant compliance, and repricing opportunities.
– Audit access rights and authorized signatories for bank and payment systems.
– Negotiate or renew merchant/acquirer and treasury services contracts.
– Evaluate hedging needs for FX, interest rate or commodity exposures (if applicable).
Annual
– Set target cash buffer (see worked example below) and liquidity policy (roles, thresholds, escalation).
– Re‑assess banking relationships and consolidate where it reduces cost/risk.
– Perform an annual fraud and controls review (external if material).
– Plan for tax payments, seasonal working‑capital swings, large capex, and dividend/capital return policy.
– Update contingency funding plan (sources, triggers, and execution steps).
Key metrics (definitions and formulas)
– Cash Conversion Cycle (CCC): measures how long capital is tied in operations.
Formula: CCC = DSO + DIO − DPO
Where:
– DSO (Days Sales Outstanding) = (Average Accounts Receivable / Revenue) × number of days.
– DIO (Days Inventory Outstanding) = (Average Inventory / Cost of Goods Sold) × number of days.
– DPO (Days Payable Outstanding) = (Average Accounts Payable / Cost of Goods Sold) × number of days.
Example (annual basis, 365 days): Revenue = $12,000,000; Avg AR = $1,000,000; COGS = $7,000,000; Avg Inventory = $700,000; Avg AP = $800,000.
– DSO = (1,000,000 / 12,000,000) × 365 ≈ 30.4 days
– DIO = (700,000 / 7,000,000) × 365 ≈ 36.5 days
– DPO = (800,000 / 7,000,000) × 365 ≈ 41.7 days
– CCC = 30.4 + 36.5 − 41.7 ≈ 25.2 days
– Operating Cash Flow Ratio: Operating Cash Flow / Current Liabilities.
Example: OCF = $500,000; Current Liabilities = $400,000 → Ratio = 1.25 (coverage of short‑term obligations).
– Quick Ratio (acid test): (Cash + Short‑term Investments + Accounts Receivable) / Current Liabilities.
Example: Cash = $200,000; ST Investments = $50,000; AR = $300,000; CL = $600,000 → Quick Ratio = (200+50+300)/600 = 0.92.
Rolling 13‑week cash forecast — step‑by‑step (practical)
1. Set opening week cash balance (bank balance + cleared deposits).
2. Project weekly cash inflows: collections by aging bucket, known receivables, other receipts. Use realistic collection rates (e.g., 60% current, 30% 30 days overdue, 10% longer).
3. Project weekly cash outflows:
3. Project weekly cash outflows (continued)
– Separate fixed versus variable outflows. Fixed = payroll, lease payments, scheduled debt service. Variable = raw materials, freight, utilities (may vary with production/sales).
– List payment timing and payment terms for each vendor (e.g., Net 30, Net 45). Map invoices to the week they will actually leave the bank based on payment policy and any planned stretching.
– Include payroll and benefits with gross amounts, employer taxes, and the week(s) for withholding remittance. If payroll is every other week, model the biweekly cadence.
– Model taxes and statutory remittances (sales tax, payroll tax, VAT) in the weeks they are due, not when accrued.
– Account for one‑time or irregular items: capital expenditures (capex), planned acquisitions, dividends/distributions, legal settlements.
– Include interest and principal on loans; treat interest as an operating outflow and principal repayment as a financing cash outflow (but include both so the bank balance impact is captured).
– Capture bank fees, merchant fees, and payroll service fees.
– Add a conservative buffer for unplanned outflows (e.g., 1–3% of expected weekly outflows) to reflect surprise payments or faster collections shortfall.
Worked numeric example for week 1 (illustrative)
– Opening week cash balance = $250,000.
– Projected weekly inflows (collections, other receipts) = $180,000.
– Projected weekly outflows:
– Payroll (biweekly portion) = $90,000
– Vendor payments = $60,000
– Taxes and remittances = $15,000
– Debt service (interest + scheduled principal) = $10,000
– Capex (small scheduled purchase) = $8,000
– Bank/merchant fees + buffer = $2,000
– Total outflows = 185,000
– Net weekly cash flow = inflows − outflows = 180,000 − 185,000 = −5,000
– Ending week 1 cash balance = opening balance + net cash flow = 250,000 − 5,000 = 245,000
4. Calculate weekly net cash flow and ending balance (formulae)
– Net weekly cash flow = Total weekly cash inflows − Total weekly cash outflows.
– Ending cash balance (week t) = Opening cash balance (week t) + Net weekly cash flow (week t).
– Opening balance (week t+1) = Ending balance (week t).
– Track the minimum projected balance across the 13 weeks; that defines your worst short-term cash position.
5. Scenario and sensitivity analysis (practical)
– Base case: your best estimate of receipts and payments.
– Downside case: reduce AR collections (e.g., collections rate −20%), delay key receipts, or increase vendor payments (e.g., accelerate supplier terms).
– Upside case: faster collections, delayed payments, or one‑off cash receipt (asset sale).
– Sensitivity checklist: vary (a) days sales outstanding (DSO) by ±10 days, (b) key customer receipts by ±25%, (c) payroll timing shifts one week.
– For each scenario, recalculate the 13‑week balances and identify the week and amount of any shortfall relative to your minimum target balance.
6. Define triggers and actions
– Set thresholds (examples only, adjust for your business size and risk tolerance):
– Green: projected minimum balance > 2× target buffer — normal operations.
– Yellow: projected minimum balance between 1× and 2× target buffer — begin cost control and confirm access to liquidity.
– Red: projected minimum balance < 1× target buffer — execute contingency plan (draw on line, negotiate payables, delay discretionary spend).
– Contingency actions (non‑exhaustive):
– Draw on committed credit line or bank overdraft.
– Accelerate collections: call major AR accounts, offer early‑pay discounts.
– Negotiate extended vendor terms or short‑term payment plans.
– Postpone noncritical capex and discretionary expenses.
7. Reforecast cadence and variance control
– Update the 13‑
-week rolling forecast at your chosen cadence (weekly is typical). Key actions:
– Rolling-horizon process — shift the forecast forward as each period (week/day) completes. Reconcile the opening cash balance to the most recent bank statement or real‑time bank balance before projecting forward.
– Cadence guidance (adjust by company size and volatility):
– High-volatility or distressed firms: update daily and reconcile daily.
– Typical mid‑market firms: update weekly, reconcile weekly.
– Stable, low‑risk firms: update monthly with a weekly short-form check.
– Variance calculation (for each line item and totals):
– Variance = Actual − Forecast.
– Percent variance = Variance / Forecast × 100.
– Cumulative variance = sum of period variances over the rolling horizon.
– Thresholds and escalation (examples):
– Minor: |% variance| < 5% — document cause, no immediate action.
– Moderate: 5% ≤ |% variance| < 15% — manager review, corrective adjustments.
– Major: |% variance| ≥ 15% or trigger moves to Yellow/Red — senior treasury/finance escalation and contingency actions.
– Root‑cause classification (timing, estimation error, structural change). Record the category for each variance to improve forecasting accuracy.
Worked numeric example — weekly rolling:
– Forecasted week cash inflow = $500,000; actual inflow = $430,000. Variance = 430,000 − 500,000 = −$70,000. Percent variance = −70,000 / 500,000 = −14%. Action: categorize as “moderate/major”, call AR lead, confirm collectability of largest receivable(s), and reforecast remaining weeks for knock‑on effects.
8. Reporting, governance, and communication
– Standard reports (minimum fields): opening cash, receipts, disbursements, net change, projected minimum balance, trigger status, key driver notes, bank balances by counterparty.
– Dashboard cadence: weekly operational dashboard; monthly board summary; immediate alert if safety thresholds breached.
– Roles and approvals: define who may change forecast assumptions, who approves drawdowns, and who can execute bank transfers. Use a written playbook and version control on the model.
– Audit trail: retain timestamps, author, and rationale for major assumption changes. This supports control and improves future forecasts.
– Communication protocol: predefine audience and channel for Green/Yellow/Red alerts (e.g., email + IM for Yellow, phone + exec committee for Red).
9. Liquidity buffer and short‑term investment policy
– Define the buffer (target liquidity) using a simple formula:
Target buffer = average weekly outflow × buffer weeks + minimum operating cushion.
Example: average weekly outflow $200,000; buffer weeks = 4; minimum cushion = $100,000 → Target buffer = 200,000×4 + 100,000 = $900,000.
– Investment ladder (ordered by liquidity/safety): operating cash (bank deposits) → overnight sweep accounts → money market funds (MMFs
) → Treasury bills (T‑bills) → repurchase agreements (repo) and commercial paper → short‑term government or highly rated corporate bonds / bond funds. Each step down the ladder trades liquidity for modestly higher yield and slightly higher credit or market risk.
Practical policy parameters (common practice — not advice)
– Maximum tenor: limit individual holdings to maturities ≤ 365 days for the buffer; set a stricter internal limit (e.g., ≤ 90 days) for the most liquid tranche.
– Credit quality: require government or top‑tier credit (e.g., sovereign, A‑ or better) for anything beyond bank deposits and MMFs; set issuer concentration limits (e.g., no more than 20% in any single issuer).
– Duration: keep portfolio duration short (e.g., 7 days).
– Counterparty limits: cap exposure to any one bank, dealer, or fund (e.g., maximum % of buffer or absolute dollar cap).
– Secondary market access: prefer instruments with active secondary markets (easier to sell quickly).
Worked example — building a $900,000 liquidity ladder
Assumptions: target buffer = $900,000 (from your earlier example); risk tolerance: preserve principal, maximize near‑term liquidity.
Suggested ladder (illustrative allocation):
– Operating cash (bank deposits, immediate access): $200,000
– Overnight sweep / demand deposit sweeps: $200,000
– Government Money Market Fund (MMF): $250,000
– 30–90 day T‑bills: $150,000
– 90–180 day high‑quality commercial paper / repo: $100,000
Total = $900
Projected outcomes and calculations (illustrative)
Below are two short worked calculations using the ladder above. All yields and time-to-cash assumptions are illustrative — replace with current market quotes when implementing.
Assumed illustrative yields (annual, simple interest):
– Operating cash (immediate access): 0.5%
– Overnight sweep: 4.5%
– Government money market fund (MMF): 4.2% (net of fund fees)
– 30–90 day Treasury bills: 4.6% (yield to maturity)
– 90–180 day high‑quality commercial paper / repo: 4.8%
Annual interest (approximate):
– Operating cash: $200,000 × 0.005 = $1,000
– Overnight sweep: $200,000 × 0.045 = $9,000
– MMF: $250,000 × 0.042 = $10,500
– T‑bills: $150,000 × 0.046 = $6,900
– Commercial paper/repo: $100,000 × 0.048 = $4,800
Total annual interest ≈ $32,200. Implied weighted average yield = $32,200 / $900,000 ≈ 3.58% annually.
Estimated weighted average maturity (WAM) in days
Take midpoint access times for each bucket (operating cash = 0 days; sweeps/MMF = 1 day; T‑bills = 60 days; commercial paper/repo = 135 days). WAM = sum(days × dollar)/total dollars:
WAM ≈ (0×200k + 1×200k + 1×250k + 60×150k + 135×100k) / 900k
WAM ≈ 22,950,000 day‑dollars / 900,000 = 25.5 days
Interpretation: this ladder keeps most assets very liquid while modestly extending maturity to pick up yield; WAM ~25 days is typical for high‑liquidity buffers.
Implementation checklist (step‑by‑step)
1. Confirm objectives and constraints
– Reconfirm buffer size, allowable instruments, counterparty limits, tax status, and any regulatory or internal policy limits.
2. Set up accounts and authorities
– Ensure bank sweeps are configured, brokerage or repo accounts are open, and trading signatories are authorized.
3. Select instruments and counterparties
– Use counterparty due diligence: credit ratings, balance sheet, average daily volume (for secondary market access), and legal documentation (master repurchase agreements, if applicable).
4. Execute initial buys/sweeps
– Fund operating cash and sweeps first. Buy MMF shares or subscribe to sweep features. Place T‑bill bids or buy through broker. Confirm settlement instructions and settlement dates.
5. Document
– Save