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Understanding Cash Flow Management

A business’ cash flow can be compared to the engine in ones car or the heart in a human body. No car will run without an engine, and the heart needs to keep pumping in order for a human to survive. Cash flow is the “heart” or “engine of a business and the goal behind cash flow management is to determine the cash needed for day-to-day business without losing investment options by having two much cash.

There are many cash management techniques to use in a business, and some vary with the products and services sold, and how the business is run. Productive cash flow management will allow a business owner to free up cash in order to make short or long term investments. However, some short-term financing is a way for a business to get immediate funds. The focus of this paper will be toward the small business owner, and it will look at both topics. This paper will show the comparison and contrasting op various techniques of cash management with one another. It will also review the various short-term offers available, and why some are better.

Cash Management Techniques
The struggle to maintain adequate levels of cash into a small business is a common problem. By projecting the inflow and outflow of your businesses cash, you can determine the amount of cash that will be available during a designated period. Various ways to do this is through a cash flow projection, shortening collection cycles, offer credit, monitor inventory, electronic funds transfer (EFT) transfers/automated clearing houses (ACH), and E-Commerce.

Preparing a cash flow projection is a useful tool in helping the financial manager to plan ahead in the coming months and years. If first starting out, projections should be done on a Source: The cash flow cycle from Foundations of Financial Mangement. (Block & Hirt, 2005) month-to-month basis, then yearly. This will provide historical data in order to take those values and determine the possible cash level. To do a cash flow projection, think of it as a personal checkbook – is there enough money there to pay the bills – or look at the bigger picture as shown in
Controlling inventory to sales so current assets do not go up and down helps eliminates having to discount items or pay for storage. An example used by Block and Hirt (2005) was McGraw-Hill and textbooks. Too many or too little textbooks produced would mean loss of sales or excess inventory that could not be sold until the following school year. Businesses should buy inventory at the best price and that can be sold within a short time, and special orders need deposits. Service businesses do not have to worry about inventory, but like most firms, they look for vendors that will offer stretch payments. Vendors that allow firms to pay within 30 to 60 day give those businesses more readily available cash. On the other hand, a business wants to expedite their customers payments and can do so by offering incentives like discounts on the entire bill or pushing up the payment cycle and include stiff late fees. (AllBusiness, 2007).

EFT is probably the most efficient and cost savings tool a firm can use. Not only will it encompass all the above actions discussed, but it can be used for direct deposit of paychecks, and allow the firm to make their payments to creditors at the last minute. It costs only nine-cents compared to issue an EFT/ACH payments compared to an 86-cent paper check. (U.S. Treasury, 2007). Reasonably priced alternatives to EFT are Regional Collection Centers or a lock box system that can cash checks quicker. However, the time period is usually 24 hours and there is an additional cost to the firm. (2007).

The world-wide web makes E-Commerce a must for business. Purchases and payments can be made 24/7. A wider range of customers can be served, and investments by a company can be made though transactions. Since the United States money is an accepted currency world-wide, EFT makes investing overseas and borrowing from foreign banks easier.

Short-Term Financing
Businesses seeking loans want the lowest interest rate possible. Since the U.S. dollar is the world’s international currency, many firms look for Eurodollar loans that offer the London Interbank Offered Rate (LIBOR). The LIBOR rate is lower than the prime interest rate, making these loans more favorable. This problem is most of these loans are given to larger worldwide companies like McDonald’s, which has numerous loans in euro-based currencies (2005).

Smaller firms seek loans from commercial banks that run from six months to a year, or a self-liquidating loan. The problem with the latter is the sale of current assets provides the cash to pay for the loan, and if the assets are not sold, a business can be bankrupt immediately. There are compensating loans that are good for small or large business. This type of loan allows a bank to supply credit to a business, but funds have to be immediately available to cover 20% of the loan fee and 10% of future commitments (Lowe, 2006).

In a trade credit, a company receives goods immediately, but does not have to pay until 30 or 60 days. Depending on the loan and vendor, a discount may be offered if it is paid with a specific time. An example would be using a credit card from Lowe’s to purchase a new kitchen. Lowe’s will finish the work but will not get paid for the work until later. Trade credits are also used as a signaling effect on the performance of both the seller and buyer. Companies with poor track records will have difficulty in getting longer credit days, so many opt not to see trade credit.

Commercial paper is an unsecured promissory note, money market or certificate of deposit issued by large banks and corporations. The short-term investment is usually for a minimum of $25,000 and to purchase inventory or to manage working capital (Wikipedia , 2007), which is why businesses selling products use this type of financing. Generally regarded as a safe investment, Block and Hirt (2005) noted bankruptcies of United Airlines, Kmart, Enron and WorldCom in 2001-2002 have caused some lenders to become.

One of the most common used short-term financing is the bank overdraft. IA bank issues the overdrafts with the right to call them in at short notice, although most have a certain period attached to them. This type of financing should not be used to purchase machinery or equipment since the bank can call in the loan at short notice. Bank drafts are good to use for companies with season fluctuations in trade, like nurseries which have down times during the various seasons.

Each business has to know how to manage its money and what finances are available if needed. If a firm’s cash inflows and outflows are mismanaged, it may face a liquidity crunch, which in turn means the business needs to borrow funding. If this happens, a business may take a loan or line of credit at a higher rate. If cash management techniques are planned ahead by a business, it can prevent this from happening. Cash flow management can also help a company to begin to show a profit and successfully stay in business.

AllBusiness. (2007). Cash Flow Management Tools. Retrieved February 1, 2007, from
Block, Stanley B. and Hirt, Geoffrey A. (2005). Current Asset Management. (University of Phoenix Custom Edition e-text). New York: The McGraw-Hill Companies. Retrieved January 28, 2007, from University of Phoenix, rEsource, MBA/503 – Introduction to Finance and Accounting.
Block, Stanley B. and Hirt, Geoffrey A. (2005). Sources of Short-Term Financing. (University of Phoenix Custom Edition e-text). New York: The McGraw-Hill Companies. Retrieved January 28, 2007, from University of Phoenix, rEsource, MBA/503 – Introduction to Finance and Accounting.
Block, Stanley B. and Hirt, Geoffrey A. (2005). Working Capital and the Financing Decision. (University of Phoenix Custom Edition e-text). New York: The McGraw-Hill Companies. Retrieved January 28, 2007, from University of Phoenix, rEsource, MBA/503 – Introduction to Finance and Accounting.
Lowe, Kevin. (2006). Managing Your Cash Flow and Tools to Use.. Retrieved January 31, 2007, from
United States Treasury. (2007). Electronic Funds Transfer. Retrieved Febuary 2, 2007, from
Wikipedia. (2007). Commercial Paper. Retrieved January 30, 2007, from