Join Jim Stice for an in-depth discussion in this video Cash management, part of Finance Foundations: Fundamentals.
- Let's begin by talking about cash management. How to manage the cash we have. As you can see here we've got a graph from Toys "R" Us. It's their quarterly cash balance from 2002 through 2012. You'll notice a pattern here. It's always lowest in October and highest at the end of January. Why would that be? Well if we stop and think about when is Toys "R" Us busy season. We'll realize that's the holidays from Thanksgiving through December. They need cash building up to October to pay for all that inventory.
They then receive all their cash in December January, once that inventory is sold. So it makes sense in the case of Toys "R" Us. They're going to have their lowest cash balance in October and their highest cash balance in January. Now here's the question, when it comes to managing cash. How to make sure they have sufficient in October. The last thing they wanna do is to run out of money. Second thing is, what are they gonna do with the excess that they have in January? What are they gonna do to make sure they have sufficient cash and what are they gonna do with the excess cash they have in January? Before we talk about those two options, let's talk about, why should they have any cash at all? As we know, cash is a low-yielding asset.
You don't make a lot of return on cash. So, they don't wanna have too much. But they don't wanna have too little. Why have cash at all? Well it turns out 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. We've got to manage our cash to ensure we have it when we need it. That requires, computers. That requires, staff. That requires, sophisticated projections to ensure that we can forecast, "Are we gonna have enough "cash when we need it?" A cash shortfall, that would be inconvenient and potentially costly.
If payroll is due on Friday and it turns out you don't have the cash there are gonna be consequences to that. So, we have to make sure we have sufficient cash. Why not have a lot? Well as I said earlier, Cash is a low-yielding asset. To have cash sitting in your savings account, you're not going to get a very large return on that. The opportunity cost of holding cash can be very high. So to ensure we have not too much and not too little, there are tools that we have to manage our cash.
The first is a cash budget. We can carefully plan and solve cash flow problems in advance. It turns out over time we can predict with some degree of certainty, "When will our customers pay us?" We can predict with some degree of certainty, "When are we gonna have to pay our suppliers?" And what we wanna do is to identify well in advance, when are we gonna need cash? We don't need to guess. We can determine ahead of time, by making a cash budget.
We can know ahead of time, "Am I gonna need to borrow money?" In October for example. "Am I gonna have excess in January?" Would you like to find out in October that you need cash tomorrow? That would present a problem. But, Toys "R" Us, in their case, they know ahead of time that they're gonna need cash in October. But for small businesses, you can figure out, "When are we gonna "have a coarse shortfall?" It's better to know that ahead of time so that you can go to a bank ahead of time and get a pre-approved line of credit.
A short-term loan. And you can show the bank, "We have a shortfall here in anticipation "of cash coming in, in the future." Knowing that ahead of time. And the only way to know that ahead of time is with a cash budget. You can go to a bank and work out the details of a short-term loan well in advance. Now, there will be occasions when you have excess. In the case of Toys "R" Us, in January. They have a lot of money. What are they gonna do with that? What are their plans with that to ensure that they can invest it, but then have access to it when they need it later in the year? So, a cash budget allows us, "When are we gonna have shortfalls of cash?" And then, "When are we gonna have "excesses in cash?" And we can have strategies to ensure we're ready for both of those eventualities.
- Understanding financial statements
- Managing finances in the short term
- Analyzing risk and return
- Obtaining short-term and long-term financing
- Understanding the stock and bond markets
- Comparing the Facebook and Microsoft IPOs
- Working with financial institutions
- Using capital budgeting
- Creating simple personal saving and investment plans