Defining Cash Management and Budget Practices in Financial Analysis

I. Objectives:

  • Defining cash management, cash, and cash budget

  • Define cash management practices

  • Define short-term investing and be familiar with short-term types of market securities

A. Cash Management

Cash management involves the firm's management of its cash, collections, and short-term investing. It is particularly important for small businesses, due to the reduced availability of affordable credit, and significant initial costs that must be managed while receivables come in. Effective cash management enables the small business the necessary flexibility to handle payroll, as well as meet any unexpected expenses.

As a result, all resources must be efficiently and effectively allocated among the current assets:

  • Cash

  • Accounts receivable

  • Inventory, and

  • Marketable securities

Successful cash management also addresses: shortening account receivables time, collection rates, short-term investments that might be suitable for the firm, and extending cash-on-hand days to promote overall profitability.


A corporate philosophy is, "The less cash you have, the better off you are." With that in mind, to ensure the firm's financial stability and solvency, managing cash inflows and outflows is critical to solvency, as well as for the firm's overall profitability.

Cash is a "non-earning asset," since it is needed for payrolls, materials, to purchase fixed assets, to pay dividends and taxes, and to service debt. It is the financial manager's responsibility to 1) minimize cash held in the process of doing normal business, while 2) ensuring there remains a sufficient amount to take trade discounts, meet unexpected (emergency) cash needs, and maintain the firm's credit rating.

The optimal cash balance is the amount needed to minimize costs, but ensure bills are paid on time. The amount of money available to meet current obligations (liquidity) is measured using any of the following methods:

  • the Cash to Total Assets Ratio

  • the Current Ratio

  • the Quick Ratio, and

  • the Net Liquid Balance

B. Cash Budget

Definitively, a Cash budget is a "detailed plan showing how much cash resources will be acquired and used over some specific time period." Cash needs are estimated during general budgeting, planning, or forecasting. The Cash Budget is generally prepared after operating budgets, including sales and production budgets, have been established. All other budgets have an impact on the cash budget. Most budgets have planned cash expenditures incorporated into them. Sales budgets, for example, impact the overall cash budget via planned cash receipts anticipated to be received on sales.

The prepared Cash Budget that shows cash inflows and outflows over a specified period typically contains combined information regarding:

  • inventory requirements forecasts

  • payment schedules, and

  • projected delays of accounts receivable collections, tax payment dates, dividend and interest payment dates

Cash Budgets are weekly or monthly. Monthly cash budgets are used to forecast yearly projected activity and operations needs.

Weekly Cash Budgets are used for actual cash control.

Monthly Cash Budgets are used for planning and forecasting purposes.

C. Cash Management Practices

Daily operating expenses must be met, but assets, such as accounts receivable that can be converted into cash at a later date, do not necessarily need cash on hold. Successful cash management involves making realistic projections, closely supervising collections and disbursements, initiating effective billing/collection processes, and following established budgetary constraints. Cash management techniques and practices have been confirmed and routinely used for decades, and are tried-and-true methods for keeping a business solvent, not close to bankruptcy, and profitable over the long term.


The Float is simply the lag time between when the firm records an amount of cash, and the when the amount is credited to the firm by the bank. Similarly, it is the time between when a check is written and when it clears the bank. Before lockbox systems and electronic payments and transfers, the float impacted the firm's money supply, although not in a big way.

It is routine for larger, more efficient, firms to operate with a negative cash balance on the books, relying on the float to carry them over on the bank's end. The negative balance is due, in part, to the firm's collection and clearing process being more efficient than that of the recipients of the firm's checks.

For example, although an equipment manufacturer may show an average cash balance of $30 million in its account, according to the bank's records, the manufacturer's book cash balance shows a minus $30 million. The net float is $60 million. Disbursements and collections must be forecast accurately to make such a large float work.

A firm's net float is its ability to quickly process collections on received checks, so funds are put to work faster. Meanwhile, it is simultaneously slowing collections on checks written, stretching out the firm's own payments as long as possible.

Float time also opens a door for fraud. Check kiting takes advantage of the float, and involves falsely inflating a checking account balance to allow an insufficient-fund check to clear. This typically goes unnoticed if funds are deposited into the account the next payday and before and attempt to clear the check is made by the bank. Electronic checks are intended to stop this type of fraud. Corporate kiting, on the other hand, involves millions of dollars. The firm may use this tactic to "borrow money" or to earn interest. Firms are generally granted immediate access to funds, so the plot can go undetected.


Cash collection systems are intended to decrease the time it takes to collect cash owed to the firm. Sources of time delays are floats: mail float, processing float, bank float, etc. Floats are time delays that add up quickly. Small businesses, new and struggling firms, may find it difficult to make their payrolls and pay their bills on time while waiting.

Cash management attempts to mitigate the impact these float periods can have on the firm by:

  • making collection receipt points more available to the customer

  • enlisting third-party payment processing vendors to receive, process, and deposit payments, or

  • lockbox systems

The effectiveness of any of these methods depends on customer location, type, and size and schedule of the payments, the firm's desired collection method, associated costs of payment processing, any time delays involved for transacting, processing, and banking, and the allowable interest rate able to be earned on excess funds.


Lockbox systems expedite check clearances at reduced costs. They often replace the regional office collection network. Virtually all banks that offer cash management services offer lockbox services as well. Using the lockbox reduces the time it takes for a firm to receive incoming checks, deposit them, process them, and get them cleared through the bank so the funds are available.

The system works by collecting a customer's check payment at post office boxes, rather than sending it directly to the firm's corporate office. Frequently (several times a day) a local bank collects the lockbox contents and deposits the checks into the firm's local bank account. The bank electronically sends a daily record to the firm of the collected receipts.


The disbursement float is immediately lost when the payer authorizes a single or recurring electronic debit. Funds are automatically transferred from a customer's account to the firm's account on dates generally specified by, or agreed to between, the customer and the firm. Records of payment appear on both the customer's and the firm's statements. The pre-authorized debits are efficient, convenient, and cost- and time-saving.


The purpose of concentration banking is to centralize collected funds. Lockbox and pre-authorized debits speed up collections, but the firm's cash becomes spread among many banks. Funds from receiving locations are transferred into one, or more, centralized cash pools. This makes it more practical for use in short-term investing or reallocation, as the firm deems necessary.

Bank deposits are recorded daily and, based on disbursement need, are electronically transferred via ACH (automated clearinghouse) from collection points to a concentration bank and concentration bank account. Each particular bank has its own file and sends and receives its data. Typically, within 24 hours, the ACH entries are forwarded for processing the actual transfer. The firm is able to effectively maximize economies of scale through investment or cash management.


Cash management not only addresses accelerated collections, but also the control of the outflow of funds. The opposite of delayed disbursement is controlled disbursement, which is used to direct check transactions through the bank. It also maximizes available cash for investment. The disbursement control system operates daily, in accordance with mandated once-a-day check distributions.


Zero Balance Accounts (ZBA) are disbursement accounts that have a zero-dollar balance. They are intended to have checks written off of them. Firms typically set up several ZBAs in the concentration bank. Each is funded from a master account. Funds are automatically transferred from the master account to cover checks presented to the ZBA. If the master account runs into the negative, borrowed funds from the bank line of credit are deposited into it.

Zero-Balance Accounts simplify disbursement and cash control. The primary advantage is to reduce the non-interest-bearing amount of cash.

D. Short-Term Investing

Short-term liquid assets or cash equivalents are short-term securities that are considered to be very liquid investments and provide the firm a return that, at the very least, accounts for inflation. Cash equivalents must also have a date to maturity that is three months or less at the date of purchase.


Short-term Non-Cash Equivalents are investments whose maturities exceed three months at the date of purchase, but are less than 365 days at the Balance Sheet date.

When the investment maturity exceeds 365 days at the Balance Sheet date, they are classified as "Marketable Securities."


Short-term market securities must be liquid investments. They do not need to be good cash equivalents by themselves, but must be able to be readily converted into cash when desired, or when it becomes necessary. Some commonly used short-term market securities include:

  • Equity - a stock or comparable security investment that is very liquid, although its value is changeable.
  • Money Markets – widely used by governments and corporations to access short-term capital. Certificates of deposit, T-bills, commercial paper, and bankers' acceptance qualify as desirable money market instruments.
  • U.S. Treasury Securities - Notes and Bonds prices are fairly unstable, however, maintaining short-term debt reduces the risk of the market falling below $1 per share.
  • Certificates of Deposit (CDs) – offered by commercial banks and other financial institutions. They pay annually-accrued compound interest, based on a specified rate.
  • Commercial Paper – unsecured promissory notes issued to the public. They are essentially a no-interest loan offered at discount that does not require collateral or SEC filing. Gives quick access to money, must mature within a nine-month period to avoid SEC regulation, and is repaid at the full non-discounted price.
  • Banker's Acceptance – a draft is drawn on a bank for payment when presented. (Funds do not need to be deposited until the draft is accepted.)


The primary goal in managing marketable securities is to maximize profitability, while maintaining capital safety and liquidity. Funds should be converted from cash into interest-earning marketable securities, if they are being held for other than immediate transaction. The short-term market securities must meet the same return on investment criteria as any other corporate/long-term investments.

Marketable securities provide significantly lower yields than the firm's operating assets. A firm invests, because they substitute for cash balances and are temporary investments, generally with some gain. The decision of what type of securities to invest in depends on:

  • the minimum investment required
  • yield
  • maturity
  • safety, and
  • marketability

Investments are composed of "available-for-sale investment-grade debt securities" the firm holds at fair value. Firms typically diversify their investments by restricting their holdings to any single issuer. This, of course, does not apply to money markets, and direct obligations, or securities issued by agencies of the U.S. government.