If you’re an investor, a small business owner or a finance executive you’ve probably heard the phrase, “Cash is Trash.” Since the Federal Reserve went on its stimulus rampage after the beginning of the great recession almost eight years ago leading to QE1, QE2 and other variations of monetary stimulus it has encouraged the interest rates to lower to zero and negative in some cases.
The savers of the world are bemoaning this policy as their cash accounts, CDs and bonds yields have plummeted, leaving their former flowing cash now only dripping. Investors have responded by trading in their cash for higher-yielding (and riskier) investments.
Surely in this environment, an entrepreneur should act just like individuals by investing as much cash into their business rather than let it sit idly in their bank account, right?
What’s the fun in letting the bank lend your savings out to you when you could easily prepay your long term debt and not owe the bank that interest?
I want to give you three reasons why I believe it is prudent to maintain an ample amount of cash on hand for your business.
1. The leading cause of death of small businesses is running out of cash
When the money runs out, your business dies!
If there were business obituaries, the primary cause of death would usually be a lack of cash. There are amazing entrepreneurs with world-changing ideas, who want to bring a revolutionary product to market. These same entrepreneurs are bound by the limitations of finance; particularly the ability to pay employees for doing something or vendors for selling them products.
There is a funny thing about vendors and employees, they go away when they’re not paid! This all requires cash. No matter how great the vision is for the product you sell, no matter the size of your potential target market and no matter the economic environment in which you operate, you will need cash to keep your business alive.
2. Cash isn’t trash, it’s king
If we are discussing cash’s proper role in your business, as opposed to investing for retirement, let’s remember that cash sits on the throne of assets. There is no better bargaining chip for purchasing from a vendor, negotiating a merger or getting terms from a banker than to show them you plan to back up what you say with cash.
3. Cash is the best form of self-insurance
Sure you have insurance on employees, property and products but what about those subjects you can’t insure. For example, let’s say the appraisal on the building you are constructing comes in low and you’re stuck with a half-constructed building and short of financing?
Or what happens when a competitor offers to sell and you’re short on collateral? In these circumstances, having an insurance policy in the form of greenbacks can mean the difference between purchasing and growing your business or watching your competition grow.
There are a multitude of financial ratios and reports you can use to analyze how much cash you need including the current and quick ratios, operating cash to debt, and my personal favorite, a forward-looking management cash flow report. Any way you slice it, having cash available helps the business run smoother. Despite the nonexistent interest being earned on your cash, it is still worth having.