Cash is an essential part of a business, and it is crucial for companies to generate cash to meet their needs.
Fremont, CA: Cash is essential to business, and business has to generate enough cash from its activities to meet its expenses and have enough left over to repay the investors and grow the business. While a company can also fudge its earnings, its cash flow gives an idea about its real health.
By generating adequate cash, a business can meet its daily business needs and avoid taking on debt. That way, the business will have more control over its activities. If a business has to take on the debt to meet its expenses, its debtors may have a say in how the business is running.
Suppose businesses fail to generate adequate cash to meet their needs. In that case, it will be challenging to conduct routine activities like paying suppliers, buying raw materials, and paying their employees, let alone making any investments. And it must contain sufficient cash to pay dividends and keep its investors happy. Some companies also utilize their cash to engage in share buybacks to reward investors.
Improving Cash Management
Even if a company is generating a profit by making more revenue than it incurs in expenses, it will have to manage its cash flow aptly. A company’s cash flow is tied to its operations or business activities, its investment activities, and its financing activities. The cash that a company generates from its operations is tied to its core business activities and offers the best cash flow management opportunities.
Striking the Right Balance
There is a balance between having too much cash on hand, out of precaution, and having an inadequate supply. If a business has too much cash, it loses out on opportunities to invest the cash and generate additional earnings. On the other hand, if it doesn’t have an adequate cash supply, it will have to borrow the money, pay interest, or sell off its liquid investments to generate the cash it needs. Suppose the business expects to create a better return on its investments than it pays in interest on its borrowings. In that case, it might decide to invest its surplus cash and borrow any additional money it needs for its activities. In analyzing a company’s balance sheet, specific ratios, such as a firm’s acid-test ratio or its most liquid current assets to its current liabilities, provide an idea about its cash management. While a ratio greater than one indicates a healthy existing assets situation, a very high ratio could mean that the firm holds too much cash or other liquid assets.