Why are companies holding cash?
Researchers have offered multiple explanations, including flexibility and taxes, which we review below. But our work adds another explanation that we call “precautionary cash holdings.” In short, companies hold cash because it helps them avoid premature failures that decimate shareholder value.
Without generating adequate cash to meet its needs, a business will find it difficult to conduct routine activities such as paying suppliers, buying raw materials, and paying its employees, let alone making investments. And it should have sufficient cash to pay dividends and keep its investors happy.
At least, there are four motives for firms to hold cash. There are transaction motive, precautionary motive, tax motive, and agency motive. There is one additional motive to hold cash that is speculative motive. Every firm can decide its own cash level.
Reasons for Extra Cash
High revenues and significant performance growth increase a company's cash reserve and may indicate that cash accumulation is so quick that management does not have ample time to use it effectively. Different industries and companies within the same industry have varied cash requirements.
In other words, a company can appear profitable “on paper” but not have enough actual cash to replenish its inventory or pay its immediate operating expenses such as lease and utilities. If a company cannot purchase new inventory, it will slowly become unable to generate new sales.
Researchers have offered multiple explanations, including flexibility and taxes, which we review below. But our work adds another explanation that we call “precautionary cash holdings.” In short, companies hold cash because it helps them avoid premature failures that decimate shareholder value.
Reasons people keep cash at home include emergency preparedness, financial privacy concerns and mistrust of banks. It's a good idea to keep enough cash at home to cover two months' worth of basic necessities, some experts recommend.
As such, the benefit of holding some money in cash is that you help reduce the chances of becoming a forced seller during an investment market downturn. By having this safety measure in place, you can help cover some expected or unexpected expenditure without negatively impacting your long-term investment strategy.
In his “General Theory of Employment, Interest and Money” (Keynes 1936), Keynes distinguishes between three reasons for holding money: the transaction motive, the precautionary motive, and the speculative motive.
According to analysts, companies are hoarding cash because it helps them avoid premature failures that might decimate shareholder value. It allows them greater investment and operational flexibility.
Why are cash holdings needed?
Having significant cash reserves gives an individual, group of individuals, or company the ability to make a large purchase immediately. It should also ensure they are able to cover themselves when they go through a rough patch financially and need to make sudden, unexpected payments.
High liquidity enables you to: Manage any sudden threats, such as covering your working capital in an unforeseen crisis. A large customer may have delayed an expected payment, tax due is more than you'd budgeted for, or sales have slowed unexpectedly and not picked up, causing pressure on being able to pay bills.
High levels of cash on the balance sheet can signal danger ahead. If cash is more or less a permanent feature of the company's balance sheet, investors need to ask why the money is not being put to use.
Cash buffers against financial risks, such as fluctuations in revenue, unforeseen expenses, or changes in market conditions, enhancing financial resilience and stability. Businesses hold cash to fulfill tax obligations, including payments for corporation tax, income tax, VAT, or other tax liabilities.
There are several reasons why some stores say "cash only". One reason may be that the store owners want to avoid credit card processing fees, which can be costly for small businesses. Another reason may be that the store is located in an area where there is limited access to credit or debit card payments.
The net cash flow figure for any period is calculated as current assets minus current liabilities. Ongoing positive cash flow points to a company that is operating on a strong footing. Continued negative cash flow may indicate a company is in financial trouble.
The three basic reasons for holding money are for a) transactions purposes, b) precautionary purposes and c) possible profit or speculation purposes.
Lower returns: Since cash is largely a risk-free asset, investors don't get the “risk premium” that other investments, like mutual funds or GICs, may come with. Inflation risk: While cash has no capital risk, inflation can erode its purchasing power – meaning you wouldn't be able to buy as much with it in the future.
As a general rule of thumb, it's recommended that businesses have at least three to six months' worth of cash on hand to cover operating expenses if possible, though you should make sure your business can afford whatever amount you set aside.
MOTIVES FOR HOLDING CASH The Transaction Motive : It requires a firm to hold cash to conduct its business in normal course. The firm needs cash primarily to make payments for purchases, wages & salaries, other operating expenses, taxes, dividends, etc.
What is the benefit of holding cash?
Holding cash or cash equivalents, such as treasury bills, within a portfolio offers the certainty that adequate liquid assets are available to endure times of instability or economic recession.
Cash refers to the physical money a business has in notes and coins, along with any money it has in the bank. The management of cash is very important as cash allows a business to pay its bills. The main cash payments a business makes include: payments to suppliers.
Firms have historically held cash balances as a precaution against tapping costly (or inaccessible) external financing, or to smooth income volatility.
In The General Theory, Keynes distinguishes between three motives for holding cash '(i) the transactions-motive, i.e. the need of cash for the current transaction of personal and business exchanges; (ii) the precautionary-motive, i.e. the desire for security as to the future cash equivalent of a certain proportion of ...
3.1. Methodology: The principle benefit of cash holdings is the following: it enables firms to undertake their profitable investments projects without raising outside funds at high transaction costs. Thus, accumulating cash would be more beneficial and more important for growth companies than for mature companies.
