Cash flow can be a double-edged sword. On one hand, a cash deficit can leave businesses scrambling to cover bills. On the other hand, excess cash can sit idle, failing to reach its full potential. Neither a cash deficit nor excess cash are good for the business.

According to an article by Business Insider, 82% of businesses fail because of poor cash flow management. Due to the cruciality of cash flow management to business survival and growth, you must learn to handle cash deficits and excess cash to keep the business on track at all times.

In this article, we’ll explore ways to manage cash shortages and surpluses, such as establishing an optimal cash level, accurately forecasting cash needs, and identifying potential shortfalls. Securing appropriate financing, renegotiating terms with creditors, and restructuring existing loans can help bridge these gaps.

This comprehensive approach will help you to efficiently navigate and manage any cash flow complexity you might encounter while managing or running a business. Let’s dig deep into what these approaches entail.

Strategies For Handling Cash Deficit And Excess Cash

Here are some proven strategies to help business managers and owners handle their cash deficit and excess cash.

1.     Establishing the Optimal Cash Level to Maintain

One of the ways to effectively manage your business liquidity is to determine the optimal cash level your business should maintain. This ensures that the business meets its financial commitments and responsibilities without holding excessive idle cash that could otherwise be invested for returns. This balance helps prevent liquidity issues and ensures that business operations go smoothly. A suggested approach to determine the optimal cash level is to calculate it using the following formula:

Projected cash outflow over the cash conversion cycle + minimum cash reserve/emergency fund.

Let’s look at what the components of this formula entail:

• Projected Cash Outflow over Cash Conversion Cycle: This is the total cash a business expects to spend during its cash conversion cycle, which is the period between paying cash to vendors for purchases and receiving cash from product sales. To determine the projected cash outflow over the cash conversion cycle, estimate all operational expenses, including purchasing inventory, paying salaries, bills, taxes, and other operational costs incurred during the ash conversion cycle.
• Minimum Cash Reserve/Emergency Fund: This refers to the extra cash set aside to cover unexpected expenses or financial emergencies. The industry standard for cash ratio can be used as a basis to determine the cash reserve to maintain.

With sufficient cash to cover the projected cash outflows over the cash conversion cycle and a reserve for contingencies, a business is able to operate at a level of financial stability that enables it handle unforeseen obligations without disruptions to its operations.

2.     Determine Cash requirements and needs using a Cash Forecast

Accurate cash forecasting is essential for effective liquidity management, as it helps businesses anticipate and prepare for future cash needs. Projecting cash flows over a specific period, preferably quarterly, helps businesses plan for the necessary funds to capitalize on opportunities and meet their needs.

To determine cash requirements or needs using a cash forecast, you must define the forecast period. As stated earlier, a quarterly period is often recommended as it balances accuracy with manageability. It is advised to use a rolling forecast that will allow for constant adjustments based on updates.

Share the forecast with the relevant stakeholders and ensure a proactive approach to effectively manage cash deficits and surpluses is developed and implemented to support the business in meeting its strategic objectives.

3.     Identifying Points in Time When Cash Balance is Expected to Fall Short or Exceed Optimal Cash Balance

As a business owner or manager, you must identify points in time when cash balances are expected to fall short or exceed optimal levels to be able to take proactive measures to manage liquidity. To identify them, you need to analyze cash flow forecasts, focusing on projected cash inflows and outflows for each period.

After that, compare the projected cash balance to optimal cash levels. This can help you identify periods of cash deficit or excess. When the projected cash balance falls below the optimal cash level, it indicates a cash deficit. If the projected cash balance exceeds the optimal cash level, it indicates a cash surplus. After identifying the periods, mark them on the cash flow forecast, carefully analyze them, and develop proactive strategies.

4.     Securing Funds from Appropriate Sources of Finance to Offset Cash Deficits

If you identify a cash deficit, one of the major proactive measures is to secure funds from appropriate sources to cover the shortfall. The best practice is to match short term of funds sources to short term deficits and long term sources to long term deficits.  

Short-term deficits are those that are expected to last for a few weeks to several months. The goal is to cover these deficits quickly and efficiently without committing to long-term obligations. You can get short-term finances for them, such as bank overdrafts, trade credit, debt factoring, short-term loans, commercial paper, and lines of credit.

Long-term deficits are those deficits that are expected to persist for more than a year. These require funding solutions that provide stability over a longer period, such as bonds, term loans, retained earnings, equity financing, and leasing.

5.     Renegotiating with Lenders and Creditors to Prevent Cash Deficits

Another effective strategy to manage cash deficits is to renegotiate and restructure existing loans with lenders. Approach your lenders to discuss extending the loan term, reducing interest rates, or altering the repayment schedule to better align with your cash flow situation. This helps to manage current cash deficits and provide a more sustainable financial framework for the future.

In addition to restructuring loans, you can renegotiate payment terms with your vendors and creditors to prevent cash deficits. This involves adjusting the timing of payments to match the company’s cash inflows. It is important you have open and transparent communication with vendors and creditors to ensure that your relationships with each other aren’t affected during the renegotiation period.

6.     Investing Excess Funds in Short-Term Securities

When you find yourself with excess cash in the business, it is essential to invest these funds in short-term securities rather than leaving them idle. This helps you earn returns from these short-term securities investments. At the same time, it helps to manage your liquidity better.

Examples of low-risk short-term securities you can invest in are treasury bills and fixed deposits. Treasury bills are one of the safest investments because they are backed by the government. On the other hand, a fixed deposit provides a higher interest rate than regular savings accounts and offers a predictable return on investment. Also, they are insured by government schemes, making them relatively safe and low-risk.

Final Words

At Mac Adebowale Professional Services, we offer expert guidance to help you navigate cash deficits and excess cash with confidence. Our tailored solutions will assist you in establishing the right strategies needed to manage cash flow complexities. Contact us at emails@macadebowale.com or macadebowaleadvisory@gmail.com, and let’s get started.