- 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%.
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 US 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.