This article is part of a larger series on Bookkeeping.
Cash management is the process of managing cash inflows and outflows and utilizing idle funds to generate passive income. It involves collecting from your customers punctually so that you can pay your bills on time, avoiding penalties and interest. The lack of available cash can impact your business’s operations, affect your ability to settle payables, and compromise your business’s liquidity.
By following these 10 small business cash management tips, you can meet short-term and long-term cash requirements and optimize return on idle funds.
1. Don’t Pay Bills Until Due
Slowing disbursements or delaying payment of bills until the due date is one way of maximizing available cash, which you can use for payroll or taxes temporarily. Delaying payment is the best option if the seller doesn’t give an early payment discount.
2. Invoice Customers Quickly Once Work Is Complete
Another way to increase cash flow is accelerating collections, which you can achieve by issuing invoices as quickly as possible. An invoice is a request for payment asking the customer to pay the amount as quickly as possible. Ideally, you should have the invoice ready within 48 hours after the work is completed. However, it’s even better if you send an invoice right away.
3. Reconcile Bank Accounts Regularly
You must perform bank reconciliations once a month to ensure that both your cash ledger and bank account are accurate and complete. As soon as you receive monthly bank statements, you—or someone not authorized to sign checks or make deposits—should start reconciling the accounts to 1) determine the status of outstanding checks and deposits; and 2) update the books for bank debits and credits. Withdrawals not recorded in your books can easily lead to overdrafts and costly penalties.
4. Utilize a Line of Credit
A line of credit is a borrowing limit that you can borrow from at any time. Having a line of credit gives your business more flexibility in managing cash payments. Getting cash from this might make sense to take advantage of vendor payment discounts and avoid late charges. However, use a line of credit wisely because banks and credit unions charge interest.
5. Accept Electronic Payments or Checks
Asking customers to use electronic fund transfers and checks is one way of reducing the presence of cash on your business premises. The more cash you keep on the business premises, the higher the risk of theft or loss. Electronic payments (EFTs and credit cards) and checks are safer to use because they reduce theft risk and speed up payments at the same time. Even if credit cards charge processing fees, it’s a small amount to pay for security and convenience.
6. Deposit All Cash Received Daily
To reduce the risk of theft or loss, deposit daily collections in the bank. A deposit creates a paper trail of what was collected and helps match bank receipts with book receipts. Note that it’s best to avoid using daily cash collections to pay for expenses prior to depositing.
7. Invest Excess Cash in Money Market
Holding too much cash either on hand or in a checking account isn’t good for your business. While it keeps your business liquid, you’re losing a lot of opportunities in earning passive income from idle cash.
A great way to use idle cash is to invest in a money market account, which is designed to maintain a constant market value of $1 per share and pay higher interest rates than typical bank accounts. While it’s very rare for a money market account to lose value, it isn’t insured federally, so beware of the risks.
8. Establish a Petty Cash Fund
A petty cash fund provides easy and fast access to cash to pay for incidental expenses. If an expense is too small to write a check for, paying for it from petty cash is more convenient than writing a check.
Read our guide on how to do petty cash accounting to learn how to set up a petty cash fund using QuickBooks Online.
9. Segregate Cash Handling and Cash Recording Duties
One of the key principles of good internal control is the segregation of incompatible duties. In cash controls, the person holding the cash or signing the checks, such as a cashier or treasurer, must not be the same person recording cash receipts and disbursements, such as a bookkeeper, A/R clerk, and A/P clerk.
However, if it’s impossible to segregate these duties in a small business environment, the owner should take an active role in cash transactions by reviewing, approving, and knowing about all cash-related transactions in the business. If you want to learn more about cash management, read our small business bookkeeping article to learn how to effectively manage cash receipts and disbursements.
10. Determine Your Cash Conversion Cycle
The cash conversion cycle (CCC) is a working capital metric that shows the average time from the point cash is used to purchase inventory until it’s collected from credit customers. In other words, CCC illustrates the number of days it takes to convert cash invested in inventory back to cash; hence, a lower CCC is generally better, but not always, as discussed below.
The formula is:
CCC = Average age of inventory + Average age of receivables – Days payable outstanding
- Average age of inventory = Average inventory ÷ Cost of goods sold x 365 days
- Average age of receivables = Average A/R ÷ Credit sales x 365 days
- Days payable outstanding = Average A/P ÷ Credit purchases x 365 days
The number of days it takes from the point you purchase inventory until you pay vendors is called the days payable outstanding (DPO). Moreover, the number of days it takes from the point you purchase inventory until you sell them to customers is called the average age of inventory (AAI). Once inventory has been sold to credit customers, the number of days it takes for customers to pay is the average age of receivables (AAR).
The main goal of analyzing the CCC is to reduce the AAI and AAR and stretch the DPO. Ideally, you want a low CCC because it represents a fast conversion of assets to cash.
- If CCC is low, it means that AAI and AAR are low and DPO is high:
- Low AAI and AAR mean that inventory is sold fast and receivables are collected early.
- A high DPO means that you’re delaying vendor payments to keep more cash.
On the other hand, a high CCC connotes a negative working capital metric.
- If CCC is high, it means that your AAI and AAR are high and DPO is low:
- High AAI and AAR mean that it takes a long time to sell inventory and collect receivables, which might indicate you have declining sales or are imposing a very liberal credit policy.
- A low DPO means that you’re paying vendors earlier, which might result in cash shortages.
A very liberal credit policy means that the business is granting too much credit sales without giving so much consideration to the customer’s creditworthiness. Liberal credit policies can result in high sales but more bad debts, fewer cash collections, and more collection costs.
Cash keeps your business liquid because it’s the primary means of paying for goods and services. With proper cash management, you can track the inflow and outflow of cash from different sources and assess if you’re utilizing it according to your needs. For small business owners, your participation in managing cash is vital to keeping all transactions accounted for and protecting the business’s cash from theft and misappropriation.