From the course: Finance Foundations

Cash management

From the course: Finance Foundations

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Cash management

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Let's talk about cash management. First, why should a company have any cash at all? As we know, cash is a low-yielding asset. The return on the cash I have in my bank account is less than 1 percent. So a company doesn't want to have too much low-yielding cash. But a company also wants to have enough cash to handle routine needs: Bills have to be paid in cash, employees have to be paid in cash, rent has to be paid in cash, insurance has to be paid in cash. A company has to manage cash to ensure that the cash is there when it's needed. If payroll is due to be paid on Friday and you don't have the cash, your entire operation will be thrown into chaos. In short, companies need to carefully manage their cash. As an example of the need for cash management, here is a graph showing the fluctuations in the quarterly cash balance of Toys"R"Us, the toy retailer. The U.S. operations for Toys"R"Us closed in 2018, but the company still operates over 800 stores outside the United States. In this cash balance graph, you notice that the cash balance for Toys"R"Us is always lowest in October and highest at the end of January. Why? Well, if we stop and think about it, we realize that the busy selling season for Toys"R"Us is the holiday season of November and December. Now, what can Toys"R"Us do to make sure that sufficient cash is available in October, and that excess cash is appropriately used in January? One cash management tool is a cash budget. We can carefully plan and solve for cash flow problems in advance. With experience, we can predict when we will collect cash from our customers and when we have to pay cash to our suppliers. We can know ahead of time when we will need to borrow cash. Toys"R"Us, for example, knows that they will need cash in October. It's better to know this ahead of time so that you can go to a bank and get a pre-approved line of credit. You can show the bank, we have a shortfall here, but our cash budget shows that we will expect sufficient cash to be collected in the future so that we'll be able to repay the loan. The only way to know of this cash need ahead of time is with a cash budget. With a reliable cash budget, you can go to a bank and work out the details of a short-term loan well in advance.

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