Managing Cash Flow

Cash flow management is an important component of economic success for both individuals and businesses. During upturns in the economy, cash flows freely and there is a temptation to be lax in the management of cash flow. However, in times of economic downturn or recession, cash flow management takes on a much more important role. In this posting, we will explore how cash flow is generated and how government policy can either increase or decrease cash flow.

Cash flow comes to individuals and businesses in one of three ways. Operations which for individuals is when they work in either their own business or for someone else and earn either an hourly wage, salary, or commission. For businesses, operational cash flow is generated by selling the goods or services the business provides.

Cash flow is also generated through investing. This involves the purchase of capital assets, holding them for a period of time, and selling them, hopefully for a profit. Capital assets are defined as anything owned that is used for personal purposes, pleasure, or investment. This definition includes most anything we own. For businesses it includes anything that appears in the asset section of the business' balance sheet.

Finally, cash flow can be generated through financing. We can always put up an asset we own as collateral, and borrow money to generate cash flow. Of course the downside of this type of cash flow generation is that the cash has to be repaid. However, in a crunch, it may be the best method available.

Government economic policy can have either a positive or a negative affect on the cash flow for both individuals and businesses. The Federal Reserve Bank has a vital role in controlling cash flow in the economy. When economic activity is high and cash is flowing freely, they tend to implement policies that restrict cash flow in order to prevent inflation. This is generally done by increasing interest rates. When economic activity begins to slow down, they will implement policies to free up cash flow generally by reducing interest rates.

In the last eight years we have witnessed the Federal Reserve Bank in action managing cash flow. In the days after 9/11, they began to reduce interest rates in order to get the economy moving again. As the economy began to grow and cash was freely flowing, the Federal Reserve became concerned about inflation and raised interest rates. Recently, the Federal Reserve has been lowering interest rates in an effort to keep the country out of a recession brought on by the mortgage crisis. This time, however, the strategy did not work and the market continued to go down. This leads a commonsense economist to deduce that there might be deeper concerns in the market besides high interest rates. So what might these deeper concerns be?

In addition to the Federal Reserve Bank's policies, the Federal Government can also increase or decrease cash flow through its tax and regulation policies. If the government decides to raise taxes, or let previous tax cuts expire raising taxes to their previous levels, cash flow for individuals and businesses will be restricted. Increased regulation of businesses and individuals also affects cash flow. This is because individuals and businesses are required to spend additional money to insure compliance with these new regulations rather than investing this cash in expansion and job creation.

Is it possible that the market continued to go down due to its speculation that the new administration will increase taxes and regulations on businesses and individuals? If this is true, what should the government do to calm these fears? I believe President Elect Obama needs to let the market know that it will place a moratorium on any tax increases and increased regulations until the economy comes out of the recession. In addition, he needs to let the markets know that he will extend the Bush tax cuts for an additional two years. This will calm these fears and return the markets back to where they should be.

This calming of the markets will begin to restore individual retirement accounts and provide increased liquidity for businesses as their stock values increase. Increased liquidity for businesses will mean fewer lay-offs and even the creation of new jobs as businesses invest their excess cash provided through increased operational cash flow.

This will calm individuals’ fears of job loss freeing them up to spend or invest their excess cash. The side benefit for government in this scenario is that revenues to the treasury will actually increase giving the government the tax increase they were initially seeking without the disastrous side effects that would have occurred had they actually increased taxes during a recession.

I am therefore encouraging everyone reading this posting to contact the president-elect and urge him to announce a moratorium on any tax increases, extend the Bush tax cuts that are set to expire on December 31, 2010, and not to place any more regulations on business during this time. I have provided a link to President Elect Obama's webside at the left so you can contact him. If enough of us make our voices heard, they will not be able to ignore us. So I urge you to take a few moments to respond and share the results of your contact with the president elect by posting a comment to this blog. I also encourage you to share your opinions whether positive or negative.