A cash management plan is important in any business whether you are a contractor, wholesaler, or even a business management consulting firm, because it allows you to be better prepared for future expenses. Your cash management plan should be easily accessible, and a major part of your businesses strategic plan. Often business owners find themselves asking the following question: “Where did my cash go?” How often do you ask yourself this question when you look at your company’s finances?
Unfortunately, many small businesses don’t proactively manage their cash. They look at what they spent their money on in the past weeks, what bills need to be paid next week and how much money is in the bank. And often hope that they have enough to make payroll at least.
This malpractice often results in stress, and sometimes the owners write personal checks to the business so they can cover their expenses.
Why it is essential to manage your cash actively:
- Know how much money you have on hand
- How much money will be coming into the business
- Know where your money is going
- Ensure you have sufficient cash to make all your required payments, i.e., payroll
- Plan for future purchases
- Build a cash cushion and reduce stress
What does that mean to manage my money actively, and how do I do that?
The first step is to have an accounting system set up, such as Quickbooks, which records all the transactions of the company. More specifically, it shows all the company’s assets and liabilities and owner’s equity. As long as all the financial data has been recorded, we can work on putting a cash management plan in place. Ideally, the cash management plan will focus on what resources we have available weekly, over the next 12 weeks, to pay all recurring expenses as well as payables that are due, and to maintain a working capital cushion. Acceptable working capital levels (short term assets – short term liabilities) vary by industry and type of company. Typically, a working capital ratio called the quick ratio (short term assets/short liabilities) of 2 is viewed as representing a good level.
The second step is to have an adequate cash management plan is to know what the weekly/monthly recurring expenses are. The following are examples of recurring costs, rent, mortgage, utility payments (gas/oil and electric and waste management services), internet, telephone, cable, copier lease payments, insurance expenses (medical, dental, auto, liability, etc.), payroll-related expenses (Gross and Net payroll, Employer taxes, workers comp. etc.), IT, etc. Once we have listed all these expenses and the corresponding amounts that need to be paid each week/month, we know what the “minimum” amount of cash is that we need to have available to pay all those expenses during a given month. All of these expenses typically have to be paid on time in order not to incur additional fees or the possibility of service disruption and are essential to keeping the business going. In most cases, these expenses will correspond to the fixed costs of the company to operate.
Next, we need to know how much cash we have available in the bank, and any petty cash the company may have, minus any checks or other forms of payments that have been made but have not yet cleared our bank accounts. It is better to use the amounts shown in your accounting software, as those balances will reflect any checks issued or wire transfers made, etc. that may not have cleared your bank yet. Also, we need to take a close look at our accounts receivable to see which payments we are expecting to receive during the next 12 weeks. It is important to note that we should only take those amounts into account, that have a high certainty of being collected, rather than expect that money will be received based on the due date. Therefore, it is essential to have an effective policy for Accounts Receivables collections in place, as it is an integral part of any cash management policy. The company needs to review existing bank or credit lines to see how much has been drawn on them and how much is available as any undrawn amount will provide a possible source of cash if there is a shortage in operating capital.
Once we have established our cash position and anticipated cash flows that the company will receive, we need to gather information on all the cash payments the company needs to make over the next 12 weeks. This entails going through the accounts payable to see when vendor payments, service provider fees, consultant fees, credit card payments, etc. are due over the next 12 weeks. All of those payments, which can easily be determined by running an accounts payable report from Quick Books, will be recorded in the cash management plan. This piece of the cash management plan is crucial, as it is these payments that we have to go through to determine which ones we might be able to push out if needed. As part of the cash management plan, a compelling accounts payable policy needs to be in place that addresses how and when the company communicates with its vendors and service providers to make sure they understand when they will get paid. It is strongly recommended to be proactive in managing those relationships so as not to be charged late fees or even be dropped as customers.
Now that we have determined what our sources and uses of cash will be over the next 12 weeks, we gain a clearer picture of what our cash position looks like at the end of each week. This, in turn, allows us to manage our cash position over the next weeks actively.
If we have an excess of cash over the next 12 weeks, our aim should be to review how we can make that “extra” cash work for us. Such as, placing it into a securities account or interest-bearing account, or it will allow us to make necessary asset purchases or pay down outstanding debt. On the other hand, if we have enough cash to meet all of our obligations, then we should work on improving our cash position in the future through increased sales efforts and a reduction in expenses. Alternatively, if we have cash deficits during any of the weeks, we need to review our collections efforts and determine which accounts we need to place a greater emphasis on collections. If this effort turns out to be insufficient and we expect to have a negative cash position during any of the weekly periods, we need to go through our payables and see which ones we can push out. By doing this, we can make sure we have enough liquidity to pay recurring charges and other payments. To address such instances, we also need to review our available bank/credit line and be ready to draw on them. In that eventuality, we need to include in our cash management plan a repayment schedule.
The cash management plan needs to be reviewed and updated weekly to be a useful management tool!
Actively managing cash is an effective means to plan the sources and uses of money in the future, and to address working capital issues before they become a problem. Furthermore, it provides insights into a company’s payment and collection practices and sales, thus allowing management to see where changes need to be made.
It needs to be noted that the difference between a cash management plan and sources and uses of cash or cash flow analysis is that a cash management plan is a tool to manage our cash position in the future actively. In contrast, sources and uses or cashflow are typically only for one point in time.
A cash management plan lets us determine which payments need to be made and which fees we want to and can afford to make over the next 12 weeks without impairing the ability of the company as a going concern.
Every successful company needs to have a cash management plan in place, whether this is done through commercially available software or an excel spreadsheet.
At Cogent Analytics, we never stop looking for ways to improve your business and neither should you. So, check out some of our other posts for helpful business information:
Cogent Analytics, LLC is a business management consulting firm, with a primary focus to help small to medium size, privately held businesses achieve success and long term profitability. Cogent provides powerful solutions with integrity and transparency to privately-held businesses throughout the United States.