“Cash is king” is an age-old saying often used to explain the failure of both businesses and consumer households. Without the proper amount of cash on hand, both of these entities can run into major trouble, and even be forced into bankruptcy.
Businesses must have cash on hand for various reasons, such as investing in new infrastructure and dealing with unexpected expenses. Moreover, a business’s cash flow is often cited as a key factor in its potential for long-term success. A company may have all the revenue in the world, but without the ability to generate cash, it can easily fail.
The same can be said for consumers. People often wonder where to put their money and immediately look to stocks, bonds, or their 401k. While it’s essential that a portion of your money grows for retirement, a new house, or a college education, it’s just as essential to keep money in liquid, easy-to-access investments that are not subject to marketplace swings or losses. Such investments not only include checking, savings, and money market accounts, but also cold, hard cash.
On that note, let’s get into some of the key reasons why cash is so important for both businesses and individual consumers.
Why Businesses Need Cash
Many business analysts state poor cash management practices as the number one reason why businesses go bankrupt. Here are some of the key advantages of cash for any business:
1. Cash Flow
For any company to survive, cash flow is the single most important financial factor. A company could have fantastic revenue, reasonable expenses, and significant income, but if its financial operations are not designed efficiently, it could still have negative cash flow.
And without positive cash flow, any company, no matter how promising the business model, will go bankrupt. Of course, if a business has just been launched, it may be able to endure negative cash flow in the short-term in hopes of achieving long-term success. But eventually, any company must focus on creating positive cash flow. Without it, a company will not even be able to accomplish the simplest of tasks: paying its monthly expenses.
2. Capital Expenditure Investments
To grow, a company often will need to invest in factories, real estate, machinery, or technology. These are typically one-time costs that require significant funds. Without cash on hand, a business may not be able to make these necessary investments and, as a result, may never be able to experience company growth.
Sure, a business can take out a loan, but even a loan will generally require a significant down payment, which will in turn require that the company have access to cash. Loans also come with interest rates that can further eat into a company’s bottom line.
3. Company Acquisition
One popular way for companies to expand is to acquire other companies, either within their niche or as a way to branch out into new areas. Consider these real life examples: Disney and Pixar, Exxon and Mobil, and eBay and PayPal. All of these acquisitions have one thing in common – cash. Without the necessary cash, these companies would never have been able to jump on the once-in-a-lifetime opportunity to buy a valuable company at a reasonable price. It is acquisitions like these that do wonders for any company’s growth potential.
4. Dividends and Share Repurchases
Two key ways that public companies reward their shareholders is through dividends and share repurchases. Dividends are a fantastic way to put money back in the shareholder’s pocket without forcing them to sell their ownership. Share repurchases are an excellent way for management to express its confidence in the company’s future growth potential and, in some situations, to signify that it feels its shares are undervalued on the public market. By instituting a share repurchase plan, each remaining share will become more valuable. However, neither dividends nor share repurchases would be options for a public company without cash.
5. Survival During Down Economies
Every company is going to have periods when things are not running at full potential. Consider a global recession that eats into a company’s sales. Without cash on hand, that company would be forced to drastically downsize its employee operations and may even have to declare bankruptcy in order to pay off its fixed expenditures. With cash, the company will be more flexible and better able to survive the downturn.
6. Emergency Preparation
Like individuals, businesses face emergencies where they need to pay expenses right away. These include legal fees and unexpected costs associated with natural disasters. Since these fees are often not built into a company’s budget, businesses must have access to the necessary cash should such situations arise. This is essentially the equivalent to an individual’s emergency fund.
7. Cuts Transaction Costs
Small businesses need to keep their expenses as low as possible. One way to do so is to avoid electronic transaction systems including services like wire transfers and PayPal, which often charge excessive fees. By paying with actual cash, businesses can cut back on these fees, which can significantly reduce their costs and increase their bottom line profits, leading to…more cash!
8. Helps Businesses Expand in the Absence of Loans
Many small businesses have had to learn the hard way that lenders are becoming more thrifty with how they loan money. If a business has cash available, it can better take advantage of opportunities to expand and make important acquisitions – options that may otherwise not be available in the absence of loans.
9. Pay Bills Faster
Particularly for smaller business, cash can be essential for paying bills. Not only do some creditors only accept cash, but other forms of payment can take longer to process, leading to unnecessary late fees. In those cases, paying in cash is the preferred method.
Why Individuals Need cash
While cash is essential for the survival of any business, it is also extremely important to the individual consumer and household for a variety of reasons:
1. Liquidity
A stock can quadruple in value, but you can’t use it to pay your rent. A 10-year treasury bond provides a much higher interest rate than one with a six-month maturity, but your money is tied up for 10 years (assuming you bought it when it was first issued). CDs also pay interest rates, but you’ll face penalties if you withdraw your money too soon.
The advantage of cash is that you can spend it however and whenever you want. You don’t have to sell shares when the market is down, CDs or bonds before they fully mature, or wait for anything to clear.
2. Risk of Loss
What do stocks, bonds, gold, and Barry Bonds trading cards all have in common? They are all non-liquid investments, meaning their worth isn’t easily accessible, and they can decrease in value.
For example, you need to sell all of these items for cash before you can use the proceeds. This process can take time and the price you sell for is subject to whatever the market will bear. In other words, if now is not a good time to invest in bonds, you’ll either have to wait for a good time before you sell yours, or sell low enough so that a potential buyer will be interested. Because you are at the mercy of the market, these investments can lose value.
Moreover, in economic times of volatility, the likelihood of such losses rises substantially. Thus, while investing should be a part of your long-term financial plan, don’t underestimate the stability and value offered by cash. Cash, unlike the best of stocks, will maintain its value even during a stock market crash.
3. Emergency Reserves
Situations where you may need a reserve include medical or dental emergencies not covered by health insurance, damage to your home or vehicle, and possible legal issues. Having physical cash on hand or money in a checking account allows you to pay for unexpected expenses without reaching for a credit card and incurring high interest debt.
4. Ability to Make Large Purchases
Increasingly, cash is becoming necessary for larger purchases like a home or car. Not only will cash give you a leg up on other potential buyers for your dream home, but even if you take out a loan, lenders are beginning to require higher down payments. Without the necessary cash on hand, you may not be able to make that important purchase.
5. Investment Flexibility and Security
Holding cash can indirectly protect market investments by giving you the peace of mind to not sell them during bear markets. If you have a cash reserve, you won’t feel dependent on market investments to pay for daily living expenses. Another advantage is that if an investment opportunity presents itself, you have the means to immediately invest. Without this, you would either be forced to sell shares of other investments, perhaps at a time when the market is down, or forgo the investment opportunity altogether.
6. Cash-Only Transactions
Some businesses, such as certain restaurants and taxis, will not accept credit cards, debit cards, or checks. Many small retailers also issue a surcharge on small purchases. Carrying cash can simplify your life as a consumer and protect you from paying extra fees.
7. Hackers Remain a Threat
Hackers have been a significant threat to investors for years. Financial institutions such as PayPal and Citibank have even been targets. Give yourself peace of mind and keep some of your money in a safe where it can always be accounted for.
Given today’s technology wars, it just makes sense to have a physical, stable investment that isn’t subject to the threat of hackers, identity theft, or other potential manipulation of electronic information. That way, if someone steals your passwords or hacks into your accounts, you’ll have available cash to pay for everyday expenses until things get sorted out.
8. Deflationary Periods
During a deflationary period, you have to worry about banks failing or stocks and bonds losing value. Luckily, there is no such worry with cash, which will increase in value in a deflationary period. By having some cash on hand, you can ensure that you will enjoy at least some gains in your portfolio should a deflationary period take hold of the economy.
9. Avoid Interest and Fees
Taking out a loan or running into debt on your credit card will force you to pay high interest rates and fees. By sticking with cash, you not only avoid hurting your credit score, but you know you won’t have to pay an amount above and beyond the initial price of your purchase. You also free yourself of the stress associated with making monthly payments on different purchases and credit cards.
10. Costs May be Higher than Expected
One of the common problems consumers face is that estimates for large projects are often higher than expected. For example, you may want to build an addition to your house and your contractor estimates the project will cost $3,000. So you take out a $3,000 loan, but the project takes longer than expected. It eventually costs an extra $500 and you may not be able to wait for another loan to be approved. With a few hundred dollars of available cash, you will be able to make the necessary payment.
Final Word
Whether you are a business or an individual, make sure you prioritize the importance of cash. For a business, its availability is essential to not only avoid the possibility of bankruptcy, but also to take advantage of various expansion and growth opportunities. As a consumer, cash represents one of the safest investments possible while preparing you for uncertain times.
What are your thoughts on cash and its importance to both businesses and individual consumers?
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