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Efficient Cash Management

Efficient Cash Management Assignment / Homework Help
Upon preparation of cash budgets after forecasting the receipts and payments, the management will have knowledge about the cash position of the firm. After knowing the cash position, the management should work out the basic strategies to be employed to manage its cash. The strategies of cash management are essentially related to the cash turnover process, that is, the cash cycle together with the cash turnover. The cash cycle is the amount of time cash is tied up between payment for production inputs and receipt of payment from the sale of the resulting finished product.

Cash cycle = Average age of Inventory + Average collection period - Average Accounts Payable period

Cash turnover = Number of times cash is used during the year = Number of days in a year/Cash cycle

Minimum operating cash It is the level of opening cash balance at which a firm would meet all obligations and is computed by dividing total annual outlays by the cash turnover.

Efficient Cash Management Strategies

Cash management strategies are intended to minimize the operating cash balance requirement. The basic strategies that can be employed to effectively manage cash are:
  • Delaying and stretching Accounts Payables
  • Speeding up collection of Accounts Receivables
  • Efficient Inventory-Production Management and
  • Combined cash management strategies.
  • Delaying and stretching Accounts Payables

    The firm should pay its accounts payable as late as possible without damaging its credit standing. This is one of the main strategies of efficient cash management. But the firm should take advantage of cash discount, if any, offered by suppliers for prompt payment. The reason is that, the cost of not taking a discount will work out more than the cost of delaying payment.
  • Speeding up collection of Accounts Receivables

    By effective collection efforts and by speeding up the collection of accounts receivables, the cash cycle would come down, thereby resulting in saving a cost to the firm. But the speeding up of accounts receivables should be done very carefully so that the customers are not lost. The average collection period of receivables can be reduced by changes in credit terms, credit standards and collection policies. Cash discounts should be given for immediate payments or payments within 10 days of invoice to encourage customers to speed up the payments.
  • Efficient Inventory-Production Management and

    Another strategy is to increase the inventory turnover, avoiding stock-outs or shortage of stocks, by the following ways:

    • Increasing the raw materials turnover by using more efficient inventory control techniques.
    • Decreasing the production cycle through better production planning, scheduling and control techniques, which will lead to an increase in the work-in-progress inventory turnover.
    • Increasing the finished goods turnover through better forecasting of demand and a better planning of production.
  • Combined cash management strategies.

    Each one of the above cash management strategies has a favorable effect on the operating cash requirement. If all of the above strategies are combined effectively, it will lead to the most efficient cash management system.


Let us assume that a firm currently takes 40 days to pay its suppliers, allows 75 days to collect receivables and a gap of 90 days between purchase of raw materials and the sale of finished goods. Total operating annual outlay = $250,000.

So, current cash cycle = 90 days + 75 days 40 days = 125 days
So, cash turnover = 365/125 = 2.92 or 3 days.
So, minimum operating cash = $250,000/2.92 days = $85,616.44

Now, let us assume that the firm applies all the above cash management strategies, as a result of which
  • Accounts payable increases by 15 days
  • Average age of inventory reduces by 20 days
  • Speeds up collection by 25 days.
The new cash cycle would be => (90-20) + (75-25) (40+15)
=> 70 + 50 55 => 65 days

So, the new cash turnover would be = 365/65 = 5.6 days

So, the new minimum operating cash requirement = $250,000/5.6 days = $44,642.86 or $44,643.

Difference in minimum operating cash requirement => $85,616 (old) - $44,643 (new) = $40,973. If a 10% of interest is applicable, the savings in interest cost would be $40,973 x 10% = $4,097.30. This is the result of efficient cash management.

Problems faced due to cash management strategies:
  • If the accounts payables are postponed too long, the credit standing of the firm may be adversely affected.
  • A low level of inventory may lead to a stoppage of production as sufficient raw materials may not be available for uninterrupted production.
  • Stock out , which implies shortage of enough stock to meet the demand for the product.
  • Restrictive credit standards, credit terms and collection policies may affect credit sales.
So, the above points must be carefully noted and viewed when applying cash management strategies.

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