Why cash management is important

It is crucial for small businesses, to understand how important cash management is to their survival. Surveys that are conducted of failed businesses, show that most failed companies, (up to 60%), say that all or most of their failure, was due to cash flow problems. Small business owners must understand that nothing matters more than cash. Making a profit is nice, cash flow is necessary; however, it is critical to understand that cash management is the key to business success.

One of the major factors to poor cash management is that start-up businesses often find themselves short of cash, right off the mark. Small business owners need to realize that existing businesses can find ways to survive, if they can find ways to generate cash. The bottom line is that cash is the single most important element of survival, for a small business. Small business owners often say that an inability to control cash is their single biggest problem. One of the most important advantages of having positive cash management is that it gives a small business, security in unstable times. It also gives a business an opportunity to take advantage of strategic investments, or take advantage of opportunities to reduce costs. It should be noted that small businesses also have to focus on the concept of free cash flow in order to establish that cash cushion. There are several principles that can help small business owners focus on good cash management. Here are a few of them-

• Realize that cash flow and profit is not the same thing. It is important to understand that financial accounting is not focused on cash flow. It is focused on net income or profit. You should also realize that over the long term, profit and cash flow, are approximately the same but the crucial difference is timing.


• Timing is very important for a small business. For example, when you make a sale to a credit customer, you recognize that sale immediately on your income statement. That's called accrual accounting. However, you must understand that you don't get the money immediately. On your cash budget and your statement of cash flows, you don't show that credit transaction until you actually receive payment. When you look at this example you can see how the gap between profit and cash flow, could be very large. If you have rapid growth in credit sales, for example, profit could far exceed actual cash received. Situations like the one described above makes smaller companies very vulnerable to running out of cash.


• You must understand what liquidity is and how it affects your cash management-There term liquidity is often used in combination with cash management. Liquidity is defined as a company's ability to pay its short-term debt obligations. In other words, if your small business has adequate liquidity, it can pay its current liabilities such as accounts payable. Most accounts payable are usually amounts owed to suppliers.

As a final note, it is important to understand that as the owner and manager of your small business, your goal is to squeeze all the cash out of your balance sheet that you can. Remember that not only do you want to get as much cash out of your business as you can; you want to keep it out in case of a potential or actual crisis. It should be noted that two of your current asset accounts are usually big drains on your cash. These accounts are inventory and accounts receivable. Inventory is the products you sell and accounts receivable are your credit accounts or those accounts that represent the credit you extend to customers. The balances in both accounts need to be converted to cash as soon as possible.