Essay Example on Cash Balance: Advantages & Disadvantages

Introduction

It is imperative to note that a cash balance is the amount of money that a company has in its bank accounts at a specific time. The term can also be used to mean the amount that is equal to the aggregate amount of cash as well as cash equivalents and other short-term investments that are reflected or shown on the balance sheet of a company at a particular date (Prescott, 2015). The paper intends to discuss the various advantages and disadvantages of having large amounts of cash in a company. Also, the paper will identify and evaluate two companies that hold large amounts of cash as well as liquid investments on their lance sheets. Lastly, there will be a discussion on why some companies would continue to increase their cash as well as their liquid balances.

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Advantages and Disadvantages of Large Cash Balance

Understandably, as the company grows, it tends to spread out its scale until it assumes many forms. The value of any company includes its assets, such as human resources, buildings, cash, and equipment (Prescott, 2015). As stated above, in financial statements, a cash balance includes the company's liquid assets that can be used for any purpose and at any time. One of the major advantages of having a large cash balance is that it leads to improved cash flow within the company as it will help the company manage its cash flow. Due to this, when there is a problem with revenue flow leading to delay or the level drops, then the company will still have enough cash at its disposal to meet its various obligations like paying workers as well as loan repayments (Prescott, 2015). A huge cash balance acts as a cushion as well as requiring less active management. Hence, financial officers can spend their time on other tasks within the company.

Another advantage of holding large amounts of cash by a company is that it can be a vital source of additional revenue to the company through earning interest (La Cava & Windsor, 2016). Therefore, for the cash balance to remain a liquid asset, it has to remain in an account that is accessible hence limiting the amount of interest it earns. It should, however, be noted that even in a savings account, a large cash balance can still earn some interest that will be a significant amount after some time. Unlike the interest that a company pays to borrow money, the interest earned on such idle and large cash balances is relatively valuable (La Cava & Windsor, 2016).

Also, it is important to note that keeping large amounts of cash balances limits a company's borrowings (Prescott, 2015). Most businesses borrow to prevent cash flow problems, and businesses without large amounts of cash balances also need to borrow to maintain their everyday purchases. In the long run, these borrowings pile up and hurt the company in terms of interest. Understandably, with large cash balance available, the business can cater for operating purchases using its cash without the need to borrow (Amess et al., 2015). As a result, the limited borrowing coupled with less use of credit cards helps to save money, thereby putting the large cash balance inappropriate use.

Despite the advantages that a company has on holding large cash balances in its balance sheet, there is one major disadvantage to this, and that is limited growth (Amess et al., 2015). It cannot be denied that money in the bank limits the ability of a company to expand. In as much as it is meaningful for any business to maintain some liquid assets in the bank, it is prudent if the rest of that cash is deployed to a more profitable concern that will help to strengthen the company (Amess et al., 2015). Instead of the money being added to the cash balance, it can be channeled to payroll and to employ more workers, investments that will earn some return, or it can be used to settle company debts. Notably, a cash balance is more secure, but when not put into good use, it does not contribute to the growth of the company.

Companies with Sizeable Amount of Cash and Liquid Investment

One of the companies which have a large amount of cash as well as liquid investment is Apple Company (La Cava & Windsor, 2016). The company design manufactures, and then markets mobile communications as well as media devices. It also deals with personal computers, portable digital music players, and watches, among others. The current cash balance of the company stands at $178, making it one of the largest companies with sizeable cash and liquid investments on their balance sheet (Locorotondo et al., 2014). Apple company has been powered by its strong earnings growth of about 40.4% as well as other driving elements; its stock has increased by 37% in the past year. The improved earnings per share, which stands at 40.4%, have demonstrated the positive earnings of the company, and this trend is likely to continue. As a result, the improved earnings have meant that the company has had a sizeable amount of cash and liquid investments in terms of stock in its balance sheet. Apple's income growth has, therefore, tremendously grew, leading to large amounts of cash and liquid investments in its balance sheet (La Cava & Windsor, 2016).

Another company that is worth mentioning is Google Inc., which is a technology company building and providing services that help to organize information (Locorotondo et al., 2014). The company is estimated to have $64.4 billion as the total cash value making it one of the largest companies. Its revenue grew and overtook that of the industry average, which stands at 5.8%. Its statements indicate that from the same quarter a year prior, the revenues had grown by 11.9% (Locorotondo et al., 2014). Because of these indications in the increase of stocks and revenue, it cannot be denied that Google Inc. is one of the companies that has a sizeable amount of cash as well as liquid investment in their balance sheet. It has also been revealed that Google's profit margin is also high, and it is estimated to be at 69.99%, which is shown to have increased from the same quarter the previous year (Locorotondo et al., 2014). Also, the net profit margin, which is at 20.77%, is indicated to be above that of the industry average. Most importantly, Google's net operating cash flow has also increased by about 50.69%, which gives $6,617. All these are indications that Google Inc. is one of the companies with huge cash and liquid investments in their balance sheets.

Why a Company would Continue to Increase Cash and Liquid Investments

As mentioned earlier, increasing the cash and liquid investments can be of importance to a company despite the few challenges that it might pose. In most cases, companies are cautious because it may be hard to sell low liquidity assets when the company is facing some financial pressure (Amess et al., 2015). As a result, many companies increase their cash and investments that can easily be converted into other financial forms.

Another important reason why a company would increase its cash and liquid investments is the need for credit and financing (Amess et al., 2015). To be able to get such services from creditors and other lenders, the liquidity ratio of a company is always considered a significant factor. The liquidity ratio informs potential investors and creditors that the business is stable, strong, and has enough assets to repay the debts (Amess et al., 2015).

Also, in case of emergency cash and liquid investments are necessary, and this is one of the reasons why a company would increase its balances. The liquidity depends on what the company has that can easily be sold quickly when the company runs out of cash. In this case, the stocks will be liquidated, inventories sold, unused supplies are returned, account receivables will be collected (Amess et al., 2015). All these are ways to increase cash balances in a company's balance sheet. However, while doing this, caution has to be taken because, as mentioned earlier, large amounts of cash and liquid investments can be a challenge to a business as it can possibly lead to limited growth.

References

Amess, K., Banerji, S., & Lampousis, A. (2015). Corporate cash holdings: Causes and consequences. International Review of Financial Analysis, 42, 421-433. www.sciencedirect.com/science/article/abs/pii/S1057521915001544

La Cava, G., & Windsor, C. (2016). Why do companies hold cash? No. rdp2016-03, Reserve Bank of Australia, Sydney. www./ho.website.rba.gov.au/publications/rdp/2016/pdf/rdp2016-03.pdf

Locorotondo, R., Dewaelheyns, N., & Van Hulle, C. (2014). Cash holdings and business group membership. Journal of Business Research, 67(3), 316-323. www.sciencedirect.com/science/article/abs/pii/S0148296313000210

Prescott, G. L. (2015). Various implications of excessive and insufficient cash balances for corporations. Journal of Corporate Accounting & Finance, 27(1), 15-22. www.onlinelibrary.wiley.com/doi/abs/10.1002/jcaf.22094