“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.
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.