When you read the word “treasury,” what do you think of? Probably a bunch of people recording transaction info, or reconciling data between bank statements and spreadsheets. A pretty tame scene overall.
That’s cash accounting.
Now, forget this image. Picture treasury as a strategic command center – something like Bruce Wayne’s Batcave, but for finance. People are analyzing data with high-tech software, evaluating the company’s strategic situation. They get a pinpoint view of liquidity, and build responses to potential crises.
That’s cash management.
Any successful company requires both cash accounting and cash management, but they must be properly balanced. By fine-tuning your treasury processes, you ensure these approaches work together to fortify your company’s financial position and raise it to new heights.
Let’s take a look at how cash management and accounting differ and why it’s so important to build a culture of cash management.
What is Cash Accounting?
Cash accounting is what most of us think of when we think of a treasury department. We record transactions, and follow standard accounting rules. We balance debits and credits on the general ledger, and offset entries.
All this stuff is necessary. So why did we make cash management sound so much cooler? Well, the major issue with cash accounting is that it doesn’t do much on its own – it might help you figure out your current cash position, sure, but it won’t provide the context for what that number really means.
Is your company overborrowed, or attracting enough investment? Are you at risk of hitting a liquidity shortfall? Internationally, are you relying too much on a foreign currency that’s often weakening in value against your home currency?
To answer these types of questions – and transform the answers into strategic plans that improve your company’s position – you’ll need cash management.
What is Cash Management?
Cash management is like the active version of cash accounting. Also known as liquidity or treasury management, cash management’s primary focus is on monitoring and controlling cash flows. It involves hedging against risk, ensuring sustainable growth, and constructing a corporate-wide cash culture.
When all these components come together, you can devise plans that stay within your company’s risk tolerance while still having the most optimal benefit.
Let’s take a closer look at each:
Cash Flow Forecasting
Successfully managing cash is impossible without cash flow forecasting. This is a data-backed process that estimates your future cash position based on projected revenue and expenses along with historical data.
Understanding how much cash you’ll have at a specific future date – say, at the end of the accounting period – informs what actions you should take right now. For instance, if you see that you’ll most likely have a good amount of extra cash over the next quarter, maybe right now is the time to invest in that expensive piece of equipment.
But you’ll also need to consider the wider, strategic landscape – if you’re predicting major market shifts that’ll adversely affect cash flow, now’s probably not the time to buy that equipment. Instead, you should focus on cutting costs and building up your cash reserves so you can ride out the market downturn.
Cash flow forecasts function as a guide to spending and saving – optimizing your liquidity levels based on internal and external circumstances. But forecasts are only useful when they’re accurate, and they’re only accurate when they’re based on solid data. Which brings us face-to-face with our old treasury friend: the spreadsheet.
It’s almost impossible to think about cash accounting without thinking about spreadsheets. One problem with these antiquated tools, though, is that they’re incredibly prone to error. So, when you use them, you run the very real risk of basing your forecasts on errors. Banking APIs, on the other hand – like those offered by Trovata – gather data automatically so that it’s always accurate. There’s no risk of transcription error, and everything is stored in a single, centralized location.
And speaking of risks…
It’s no secret that managing cash comes with a lot of risks. Let’s look at an example: say you thought you’d make a certain amount of sales during a specific period. As a result, you took out a large loan to finance a piece of equipment.
But – uh oh – the projections were overly-optimistic, and you didn’t actually sell as much as you thought. Now you’re in a situation where you can’t meet the repayment terms without making large cuts and substantially modifying your short- and ultimately long-term plans.
The easiest way to hedge against this kind of risk would be to build a larger liquidity position. With larger cash reserves, you’d be able to afford the repayment terms even if your projections were off, or avoid taking out the loan in the first place.
What if you can’t get access to lines of credit when you need them, or interest rates fluctuate? Building a larger liquidity position will also help you out here (not to mention, banks like lending to companies that have a healthy cash position).
Next, when it comes to doing business internationally, cash management understands that not all cash values are the same. It involves hedging risks associated with different currencies through forward contracts or strategic diversification.
There’s also an inherent level of risk in cash management itself – it depends on cash forecasts being accurate! To avoid this risk, make your cash forecasts as accurate as possible by basing them on solid data. Perform variance analysis to make your future forecasts better, and leverage automation and machine learning to provide deeper insights.
Set specific cash targets to help manage risk. Do scenario planning and determine how much liquidity you’d need to make it through certain events (for instance, a few months without being able to access loans). Software can help make scenario planning simpler with user-defined variables, which allow you to see how a certain spanner in the works might affect your cash flow.
How can a profitable company fail?
No, this isn’t a trick question but, in true clickbait fashion, the answer may surprise you (or not, if you’ve been following along up until now)!
It’s by ignoring cash flows. By failing to adequately line up revenues and expenses, they might run into a liquidity shortfall – a situation where they can’t pay down their debt. We often see this in companies that grow at a super fast rate.
They’ve been using all their money to acquire new customers, increase production, and hire new employees. The problem is they didn’t build up sufficient cash reserves to keep pace with this growth.
In other words, they didn’t focus on sustainable growth, and now they find themselves in a difficult spot, perhaps having to resort to mass layoffs.
By focusing on cash management, you can avoid events like this. It all comes down to lining up inflows and inflows. That necessitates a close understanding of your accounts payable and accounts receivable aging details. You’ll also need to understand your specific cash conversion cycle – that is, how long it takes you to turn inventory into cash.
Focus on Liquidity
So we’ve talked a lot about liquidity and cash reserves. How much liquidity should you actually have? There’s no exact right answer – it can depend on your industry and strategic goals, as well as your particular cash flow cycle.
Tools like the current ratio, however, can provide a generalized benchmark. The current ratio is so-named because it compares current assets to current liabilities. The formula for this ratio is simple:
Current assets/current liabilities
A result of 1 means you have enough liquid assets to cover liabilities over the next 12 months. But, obviously, you’ll want a result higher than that so you can pay liabilities and invest in your company’s growth.
It’s also best practice to build up an emergency fund so you’re not always running to banks in a crisis – banks that’ll be hesitant to lend you anything since you don’t have a strong liquidity position. Is it possible to have too much cash on hand? Definitely.
Remember: the goal of cash management is not necessarily to maximize liquidity, but to create a reasonable hedge while using extra funds in the most optimal ways.
If your ratio results are much beyond 2, it shows you have a lot of cash sitting around that’s not doing anything for you – helping your company grow, or being invested. Too much liquidity can also make investors wary, as it makes them believe you don’t have a vision for expanding your business.
Build a Cash Culture
We’ve used the word cash a lot in this post. In case it’s not clear yet, your business is all about cash! So why not make cash your business?
Building a cash culture means focusing on hard liquidity metrics like operating and free cash flow, and even days cash on hand. It means involving the treasury department in strategic planning based on deep analysis of the data.
A cash culture prioritizes shortening the cash conversion cycle by collecting accounts receivable faster, and negotiating longer repayment terms with suppliers. It requires developing a cash preservation mindset and avoiding unnecessary expenses.
To summarize, building a cash culture means doing cash accounting, yes, but moving more focus to cash management. It involves helping the treasury department transform from stagnant number-crunching to agile financial planning. And for that, there’s one thing you’ll need… automation.
Why Automation is Key to Successful Cash Management
Why do so many companies focus on cash accounting, not cash management?
The answer is clear: finance teams spend so much effort on recording and reconciling numbers that they don’t have time to actually analyze those numbers.
They simply don’t have the resources. And so, the treasury department remains stagnant, doing enough to “get by” but not actually building a strategy that’ll help the company fortify and expand its market position while minimizing risk.
So, how do you get the resources?
Well, the most obvious way is by increasing headcount. But that’s certainly not the best option as it means substantially higher costs. Instead, why not make it easier for existing employees to get through those cash accounting activities, either by speeding them up or automating them? Time is just as important a resource as money.
Enter: Open Banking APIs
With APIs, technology-based solutions provide near real-time insight into your cash position across all bank accounts. There’s no need to spend time on reconciliation, as data is recorded automatically – it’s completely error-free right from the get-go.
Cash flow forecasts can then be generated automatically based on historical data and machine learning algorithms, which grow more and more accurate over time. Look for software that includes ERP integration, since, as mentioned, it’s impossible to get an accurate picture of your cash flow situation without AR/AP aging details.
Companies hoping to leverage the full power of cash management simply can’t do so without modern, automated solutions that provide all the financial information and liquidity context you’re looking for on the fly.
Learn how CrowdStrike digitally transformed its treasury, leveraging APIs for cash management automation, taking home the award for runner-up at the Eurofinance Awards.
Build A Cash Management Strategy
You can’t have cash management without cash accounting. But without cash management, you can’t streamline your business’s long-term growth.
To ensure success, treasury departments must go beyond reconciliation and reporting and focus on risk management, cash flow optimization, and execution of solid, forecast-based plans.
Trovata can help you get there. We specialize in providing cash transparency across corporate bank accounts and currencies, doing the mundane work for you so your finance team can concentrate on more value-added activities.