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Print this chapterThe 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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