The Importance of Cash and Cash Management
Management of cash is the primary concern of most entrepreneurs when they start a business. How will they ensure they collect funds in time to pay their bills? Cash management is also a key concern for most households. For example, I may know that I make enough money to pay all my bills, but if the timing of when the cash hits my bank versus when my bills are due isn't in sync, I run the risk of penalties or worse.
Reasons for Maintaining Cash on Hand
The main reason a business maintains cash on hand is to meet financial obligations.
Learning Objectives
- Explain the importance for always having cash on hand
Key Takeaways
Key Points
- Liquidity is the ability to meet obligations when they come due without incurring unacceptable losses.
- Banks can generally maintain as much liquidity as desired, because bank deposits are insured by governments in most developed countries.
- Banks can attract significant liquid funds to generate stronger profits, more stability, and more confidence among depositors, investors, and regulators.
- Cash is the most liquid asset and can be used immediately to perform economic actions like buying, selling, or paying debt, and meeting immediate wants and needs.
- Bank can attract significant liquid funds to generate stronger
profits, more stability, and more confidence among depositors,
investors, and regulators.
Key Terms
- money market: A market for trading short-term debt instruments, such as treasury bills, commercial paper, bankers' acceptances, and certificates of deposit
- liquidity: Availability of cash over short term: ability to service short-term debt.
In business, economics, or investment, market liquidity is an asset's ability to be sold without causing a significant movement in the price and with minimum loss of value. Money, or cash, is the most liquid asset, and can be used immediately to perform economic actions like buying, selling, paying debt, and meeting immediate wants and needs.
In bookkeeping and accounting, cash refers to current assets comprising currency or currency equivalents that can be accessed immediately or near immediately (as in the case of money market accounts). Cash is seen as a reserve for payments and as a way to meet financial obligations.
Cash: A business's cash account is how much currency it has on hand at a given time.
In banking, liquidity is the ability to meet obligations when they come
due without incurring unacceptable losses. Managing liquidity is a daily
process requiring bankers to monitor and project cash flows to ensure
adequate liquidity is maintained. Maintaining a balance between
short-term assets and short-term liabilities is critical. For an
individual bank, clients' deposits are its primary liabilities (in the
sense that the bank is meant to give back all client deposits on
demand), whereas reserves and loans are its primary assets (in the sense
that these loans are owed to the bank, not by the bank). The investment
portfolio represents a smaller portion of assets, and serves as the
primary source of liquidity. Investment securities can be liquidated to
satisfy deposit withdrawals and increased loan demand. Banks have
several additional options for generating liquidity, such as selling
loans, borrowing from other banks, borrowing from a central bank, such
as the U.S. Federal Reserve Bank, and raising additional capital. In a
worst case scenario, depositors may demand their funds when the bank is
unable to generate adequate cash without incurring substantial financial
losses. In severe cases, this may result in a bank run. Most banks are
subject to legally mandated requirements intended to help banks avoid a
liquidity crisis.
Source: Boundless, https://courses.lumenlearning.com/boundless-finance/chapter/the-importance-of-cash/
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