Effective cash management is vital to any organization regardless of size. Cash shortfalls can cause distress and lead to unwanted consequences including incremental external financing, missed opportunities and even bankruptcy. Effective cash management allows a business to conduct its daily operations without these additional stressors, pursue growth and make strategic decisions based on its goals for the future.
Most business managers understand the importance of cash in their operations. Fewer understand what steps should be taken to manage it. While there are many ways to manage cash flows, we recommend focusing on three key areas in which a business has the most control.
Accounts Receivable – In an ideal world, customers would pay for goods or services immediately upon receipt. Unfortunately, that is not realistic or practical and accounts receivable are a necessity. It is important for an organization to have procedures in place to adequately manage its accounts receivable. By effectively managing accounts receivable, an organization can more quickly take sales and convert them into cash. Ways an organization can improve its accounts receivables management include:
- Establishing a customer credit policy that dictates who should receive credit, how much credit will be given, and what terms are appropriate
- Utilizing an aging receivables report to manage collections
- Encouraging customers to pay close to within terms
- Charging interest on late invoices and reducing or cutting-off credit limits for overdue customers
- Automating the process of receiving payments to ensure on-time collections
Inventory Management – Too little inventory can cause shortages, which result in delays or losing customers. Too much inventory means sitting on items that are not quickly sold and consuming cash that could be deployed for other purposes. Inventory managers should strive to find the ideal balance between having enough inventory on hand to fill orders and keep customers satisfied, but not so much that it sits idle, increasing costs and tying up important cash resources. Optimized inventory management might include:
- Automating inventory management through ERP software
- Reviewing inventory levels and offerings frequently
- Setting up drop shipments to reduce inventory levels on hand
- Tracking sales trends to predict demand and increase or decrease inventory levels as needed
- Measuring appropriate key performance indicators (KPIs) to more accurately assess inventory needs
Accounts Payable – Typically, overlooked as a way of improving cash on hand. There is much more in the accounts payable process that can be done other than just making sure invoices are received and paid on time. The accounts payable process can be utilized as a method of cash management in the following ways:
- Tracking payables trends to forecast future cash needs
- Evaluating the attractiveness of supplier discounts for early payments
- Reviewing key metrics, such as days payables outstanding, to assess whether your full credit terms are being taken advantage of
- Renegotiating longer/more favorable vendor terms
Effective cash management is an important part of any well-functioning and growing organization. At times, it can mean the difference between a thriving or growing business and a failing one. Focusing on the three key areas outlined above will help an organization ensure its cash is being managed effectively and position itself for ongoing health and long-term success. To learn more about how RSM can assist you with your other business needs, contact RSM’s management consulting professionals at 800.274.3978 or email us.