Cash is king - or so the saying goes - and any business person will tell you, this saying is as true today as ever. And managing it is like a high-wire balancing act. If your business’s cash reserves aren’t sufficient, you may wind up short of funds. If your business holds too much cash, the funds are idle and not being pumped back into the business or generating any beneficial return.

So what sort of cash flow policy is appropriate for your business?

Fundamentally, there are two opposing approaches to managing cash and other short-term assets:

1. A flexible approach, where a business:

  • Keeps a large balance of cash;
  • Maintains a large inventory; and
  • Provides liberal credit terms and generally has a high level of accounts receivable/debtors.

2. A restrictive approach, where a business:

  • Holds small amounts of cash;
  • Keeps its inventory tight, and
  • Offer no credit and has no accounts receivable.

With a flexible policy, a business essentially chooses to incur costs with the expectation of reaping benefits in the future. For example, keeping large amounts of cash on hand is costly because the business could be getting good returns by using the money to buy machinery or invest in new projects.

Maintaining a large inventory is also costly because it ties up cash until the merchandise is sold and requires spending money on warehouse space and insurance.

But down the track, those costs will produce benefits. A business with large cash reserves is unlikely to come up short when creditor payments are due and is likely to have the money it needs to take advantage of opportunities on short notice.

It may cost money to keep a large inventory, but the stock can help boost profits because consumers are generally willing to pay more if they can get quick deliveries. Generous credit terms let a firm charge higher prices and generate goodwill and customer loyalty.

So what is the right policy for your business?

Choosing the right policy for your enterprise depends on a number of considerations.

If your business operates in a high-growth industry and has little access to external financing, it would likely opt for a flexible approach and keep cash reserves high. That would allow it to quickly move on an opportunity without financing and to remain current on payments to creditors.

A flexible approach is also appropriate for organisations that rely on repeat business. Favourable credit terms build a loyal customer base and large inventories allow for fast deliveries. Both factors help keep customers coming back.

But the costs of maintaining inventory may be unjustifiably high in industries where repeat business is less important and customers don’t expect immediate delivery.

The decision is ultimately yours, but it is important you understand the philosophy you have adopted and leverage off it to maximise your returns.

To continue the conversation and determine what cashflow strategy is right for your business, contact us at Platinum Accounting & Taxation.