September 2, 2018

5 Reasons Why Cash Is King

The age-old saying “Cash is king” has been with us for decades. Historically, the concept has often been used to explain business failures. Without an adequate source of cash on hand, it is all too easy for a business to experience major issues ranging from an adequate capital to expand to an inability pay creditors as and when they fall due.

Insufficient cash can even force an enterprise into receivership or even into bankruptcy.

The Enduring Value Of Cash On Hand

Businesses need to ensure sufficient cash is on hand for a range of prudent management reasons, be it investing in new infrastructure, having a liquidity buffer to deal with unanticipated expenses or to take advantage of unexpected market opportunities.

Why Businesses Need Cash

Many business analysts, auditors and receivers state poor cash management practices as the number one reason why so many businesses enter bankruptcy. Here are five of the prime advantages of having cash on hand for any business, regardless of what industry or sector they are operating in:

1. Cash Flow

For any company to survive, cash flow is undeniably the single most important financial factor determining its propensity for success or failure. A company may have promising revenue streams, a frugal expense base and significant income but if its financial operations are not designed and managed efficiently to spin off cash, it could still produce a negative cash flow.

In the absence of a positive cash flow, any company regardless of how promising its business model, may inevitably go bankrupt.

In the age of Internet businesses, where major brands seem to operate for years without succeeding in becoming cash flow positive, this concept may appear quaint and shortsighted.

However, eventually, every company needs to focus on creating a positive cash flow, if only to be able to pay its monthly expenses. Without it, the company risks using up its store of investor goodwill and losing their ongoing support.

2. Investment In Capital Expenditure

To nurture an enterprise the organisation will often need to invest in manufacturing facilities, plant and equipment, real estate or developments in new technology such as Big Data and AI.

These are typically one-off costs that usually require access to substantial funding. Without the luxury of cash on hand, a business may be frustrated in its ambitions to make these growth-related investments and fall behind competitively losing out on the opportunity to secure long-term growth.

3. Funding Potential Acquisitions

One popular path to growth or as a means to enter new market sectors or geographies is the traditional acquisitions and mergers strategy. Many such acquisitions have one common thread, a substantial cash component.

Without the flexibility to offer cash rather than shares, many companies struggle to convince the shareholders of their target companies to sell. Thus, they miss out on a potential the once-in-a-lifetime opportunity to acquire a strategically valuable company at an attractive reasonable price.

Many successful companies have used deftly executed acquisitions to gain a strategic footprint in a market, buy transformational technologies or to acquire a major competitor blocking their path to growth.

4. Dividend Payments And Share Buybacks

Two of the main ways public companies reward their shareholders for their support is via a reliable dividend stream complemented by share buybacks. Dividends are an attractive means of putting cash back in its shareholder’s pockets without forcing them to give up their share ownership by selling.

Share buybacks are an excellent way for management to demonstrate its belief that its shares are undervalued on the public exchanges. By implementing a share buyback scheme, each remaining share becomes more valuable as the number of shares available for trading declines. However, neither dividends nor share repurchases are viable options for a public company without the cash required to finance them.

5. Survival During Economic Downturns

All bull markets come to an inevitable end, just as every buoyant economic period invariably runs out of steam and flattens out. When an economic downturn looms, a savvy business ensures it has sufficient capital to both weather the downturn and to capitalize on opportunities for growth that emerge during economic corrections.

Without cash on hand, a company is likely to be either forced to drastically downsize its operations and potentially shed staff or even declare bankruptcy in order to pay off its fixed expenditures. With cash reserves, the company is better placed to survive the downturn.

Final Observation

All ambitious businesses need to ensure they prioritise the importance of generating a reliable and predictable cash flow. For a business, the availability is essential not only avoid the possibility of collapse and bankruptcy but also positions the business to fuel its core business organically, take advantage of expansion opportunities and explore high-growth oriented investments and acquisitions.

Filed Under: Accounting, Business Advisory, Culture, Financial Awareness

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