Cash flow management involves more than forecasting cash inflows and outflows. It also includes striking a balance between working assets and cash set aside for long term growth. When a business maintains excessive cash reserves, it can limit current productivity. On the other hand, insufficient reserves can lead to insolvency, operational delays, and the inability to fund expansionary projects.
When deciding how much cash to keep in reserve, business leaders must find equilibrium between long-term safety and short-term productivity. So, to successfully strike that balance, a cash flow management strategy should cover each of these objectives.
An Effective Cash Flow Management Strategy Ensures Adequate Reserves
A successful cash flow management strategy will allow a business to adapt to any circumstance. These circumstances could be negative, like decreased demand for products or unexpected costs. They could also be positive, like outgrowing a facility or the development of new technology to meet customer needs. When determining how much cash to keep in reserve, a business should consider their ability to do each of the following:
React to Unforeseen Circumstances
Cash flow management strategies should ensure that operations are not interrupted when a company incurs unexpected costs. Adequate reserves allow a business to react quickly when machinery breaks, buildings need maintenance, or stock is damaged. Businesses that maintain cash reserves are also equipped for unforeseen market conditions which can lead to downturns in demand, shortages in supply, and logistical delays.
The amount of cash reserves required for a business differs by industry and organizational structure. A robust risk management plan can help identify business specific risks and determine the appropriate amount of cash reserves to mitigate those risks. In general, a business should have sufficient emergency cash to pay suppliers, vendors, and operating expenses for several months in the event of a revenue disruption. The COVID-19 pandemic is one such example. In the case of a prolonged or extreme market downturn, a sufficient cash balance can ensure that a business is able to meet its short-term obligations and continue operations when possible.
Plan for Capital Expenditures
An effective cash flow management plan can also help businesses prepare for future expansion. Putting money aside during good times can help to ensure that a business is prepared for growth activities like purchasing a subsidiary, buying a new building, or investing in a piece of equipment. A business that plans for capital expenditures ahead of time ensures that they have sufficient cash to make the purchase or to acquire preferrable financing without impacting profit in the short term.
Maintain the Option for Investment
A business should be able to invest immediately if an opportunity for increasing market share or delivering more value to customers arises. Whether the opportunity is new technology, new talent, or a new idea, a business should be able to capitalize without the delay of selling off assets. A business can adapt more quickly than their competitors and be first to market with solutions if they maintain appropriate cash on hand to invest in new ideas.
Once a business has determined the appropriate amount of cash reserves to keep on hand, the next important consideration should be protecting that cash.
An Effective Cash Flow Management Strategy Ensures Safety
It is important to consider the safety of business deposits when determining where to invest reserve cash. Market fluctuations can affect the value of investments like stocks, bonds, and mutual funds. For this reason, many businesses choose to keep their emergency reserves in a savings or money market account. While cash sitting idly in an account does not fluctuate wildly in value, there is still risk of losing funds in the case of bank failure. Accounts at FDIC member banks are protected against bank failure through the Federal Deposit Insurance Corporation [FDIC] but there are important limitations to be aware of. FDIC only covers $250k per ownership category at member banks.
Historically, extending FDIC insurance to cover the entirety of a business’s cash was a laborious process involving spreading cash between multiple banks. Advances in financial technology, or fintech, have revolutionized this process. Our company, the American Deposit Management Co. [ADM], has developed technology that allows businesses to achieve the highest level of protection for the full sum of their cash – without the added hassle of maintaining and reconciling multiple bank accounts. But insurance for your reserve cash is only a part of the equation.
Large contracts, like those for capital expenditures, can bring about additional transactional risk. ADM’s Escrow Management Services can help reduce risk during large transactions. Having a neutral third-party act as a custodian of assets can ensure that contract terms are met by both parties. This means buyers are protected from non-delivery or delivery of inferior products because funds are not released until after the sale occurs. On the other hand, sellers can be assured that funds for the transaction will be available when they provide the goods or services detailed in the contract.
An Effective Cash Flow Management Strategy Considers Liquidity
There are many reasons to keep cash reserves in an accessible account. As noted earlier, business leaders need to be able to react swiftly when problems arise. They also need to act equally as quickly to opportunities. But to react swiftly, a business must ensure that their cash reserves are accessible when they need them.
Traditional investments, like CDs or mutual funds, do not always provide the necessary liquidity. With mutual funds, investment values can fluctuate making it disadvantageous to withdraw funds when markets are down. There may also be sales loads and settlement time frames to consider with this type of investment. CDs can be a beneficial investment – if there is a robust cash management plan in place, that includes detailed inflows and outflows, coupled with a CD ladder strategy designed to increase return and provide needed liquidity. However, CDs often contain penalties for withdrawing before maturity, which can make it expensive to access funds when they are needed in emergency.
Once a business’s cash is safe, it makes sense to look at the return that is being earned on cash. That’s because idle cash equals lost profits.
An Effective Cash Flow Management Strategy Ensures a Competitive Return on Cash Reserves
Whether funds are earmarked for expansionary projects or are set aside for an emergency, cash reserves are intended to bring value to the company at a future date. However, when there are funds not being used for immediate profit, there is opportunity risk. This risk can be mitigated by ensuring that cash reserves are earning a competitive rate of return.
As reserves grow, it becomes more important to ensure that they are earning a competitive interest rate. Because of inflation, cash that isn’t working can lose value, and that can reduce the effectiveness of a cash management program. If your reserves are earmarked for a long-term purchase, the effects of inflation can be even more severe.
At ADM, our flagship product, the American Money Market Account™ [AMMA™] solves the safety, liquidity, and return issues that plague business cash management – with a single deposit and a single monthly statement.
Cash Flow Management Made Easy with AMMA™
Because of the AMMA™ account by ADM, businesses no longer need to choose between safety, accessibility, and return. Thanks to our proprietary fintech, businesses can have it all – FDIC insurance, next-day liquidity, and the most competitive rates of return.
With AMMA™, business cash reserves are automatically invested across our nationwide network of community banks. This extends FDIC coverage to the entirety of business cash holdings with a single account – and the best part is you keep your current bank. We are not here to replace your bank we are here to enhance it.
If your business needs extended FDIC insurance, more accessible cash reserves, or access to the most competitive return, ADM can help. Our team is our secret sauce, and you will understand that when you give us a call.
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