Every business needs to manage its cash. Ineffective cash management can lead to lost profits, difficulties with creditors, and bankruptcy. Lack of cash is a bigger obstacle to growth than lack of profitability. Ensuring that cash flow issues don’t obstruct the organization’s progress is a top priority for a CFO.
In your own role, you should be aware of your CFO’s key cash flow considerations. This means being able to answer questions such as “Why is cash held?” “How much cash is enough?” “Can inflows be increased?” and “Can outflows be delayed?”
Why is cash held
The first question is “Why is cash held?” An organization holds cash to ensure it has four main things.
1. transaction balance — An organization needs to hold a transactions balance, which is cash to cover day-to-day transactions conducted as part of its normal operation.
2. precautionary balance — An organization should ideally hold a precautionary cash balance. This is cash to cover the possibility that the value of actual transactions exceeds the amount held as a transactions balance.
3. speculative balance — An organization might hold a speculative balance, which is cash available to enable the organization to exploit any unexpected opportunities that arise. The speculative balance is an amount above what’s required for transactions and precautions.
4. compensating balance — Some organizations keep compensating balances, which are cash balances in bank accounts that “compensate” the bank for the services provided. In some instances, banks require organizations to keep a specific amount or average balance in a low- or non-interest paying account in return for loans or services.
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