Certain companies hold a substantial amount of cash in the current times. In an environment of inflation doesn’t sound sensible. However, having cash amid a recession is smart. Let’s review the options the typical business makes and the benefits and drawbacks of each. In this context, “cash” refers to the accounts of banks and money market funds. Treasury bills and other short-term liquid assets.
The context of the discussion is late in 2022 when many economists–including me–are forecasting a recession. Despite some announcements of layoffs, most companies aren’t able to get as many employees as they wish to hire. Supply chain challenges have gotten easier. However, they are still higher than normal across many sectors. In addition, interest rates are increasing and boosting the returns from cash considerably when compared to the previous year.
The options, which fall into broad categories, are to hold onto money, use it to pay off debt, purchase inventory, acquire assets, or give dividends to the owners.
The idea of holding onto money is always a great choice, but it’s not always the best option. It’s beneficial because it offers options in the future. This could be one option discussed in the following paragraphs, but with the option of a delay. There’s no downside risk in holding cash. It also allows the opportunity to profit from potential upside opportunities shortly. In the face of inflation, the purchasing ability of cash diminishes with time. However, the value of dollars in the asset does not decrease.
In the present, not like the previous years, cash pays back. Treasury bills that are three months in length and secure if they do not completely collapse, the United States does not collapse, pay barely four percent interest, just like commercial paper. Smaller businesses can get appealing CD rates.
Another alternative is for the company to settle the debt. Most of the time, the bank loan will have more interest than the cash it earns. But there’s a huge distinction in the strategic value of making a payment on the credit line and making installments on debt. That is the term. Paying down a credit line reduces interest costs and allows you to draw on that credit line later on. Banks generally view the process of paying down the line as an indicator of the strength of their financial position. As cash offers options in an upcoming time, credit cards give the same possibilities.
The process of repaying the term loan is not the same. In the majority of business loans, a late payment fee is charged. Regular monthly payments are often required, and if the company requires cash in the next few months, it will likely be in danger. Most of the time, a better strategy is to put aside the funds to pay down loans through an interest-earning bank account. The gap between interest cost and the interest earned is negative for the business; however, it compensates by having the option of keeping cash in the bank in case the circumstances change.
It’s something that might not have been thought of in the past. It’s probably not a good idea in the case of products that become obsolete rapidly, are seasonal, or could be susceptible to theft. However, consider, for instance, a retailer of nuts and bolts. The bolts will eventually be sold. The business is protected from disruptions to supply. For producers, increasing the finished goods inventory can prevent a plant from closing because of illness among employees. Inventory shouldn’t rise excessively. However, an increase of a few percent could be a smart investment.
It is also taken into consideration. It could be capital equipment like trucks, computers, or even machinery. It could also be a different business. Real estate could eventually be used to expand. The current state of the labor market encourages equipment to fill in for employees who aren’t hired. The disadvantage is that after the money is spent, it can’t be used to withstand the onset of a recession. Therefore a cash flow projection as part of a forecast for a recession should precede any major capital investment. A large portion of the equipment a business might consider purchasing is already on backorder since other companies are also thinking similarly. The best deals could be found when we enter a downturn, while the employment market could ease also, but only temporarily.
The acquisition of another company, for example, as a competitor or to expand its geographic reach, is always risky. However, it can be a good option. Be sure to include the possibility of a recession in the valuation, not just a look at the recent profit. Like capital expenditures, you should run cash flow projections before time.
The best deals are most likely to be offered during recession or immediately. Therefore, a business looking to make an acquisition should wait until the pain gets more severe for possible prospects. However, if an opportunity arises, for instance, due to an owner’s death or retirement capacity to react quickly could enable buying at a fair cost.
In the end, the option is to pay dividends as cash to owners. From the company’s point of view, this is a poor option. But, the business wasn’t established solely as an enterprise; owners put the money into it to get some return on their investment. If the owners wish to pay an increase in their dividends, there’s no disagreement with them. (If the dividend could affect your ability to settle debts and other obligations, consult your attorney before making any decisions.) Sometimes, a closely held business owner requires a huge dividend from one company to keep the other company. It’s a good option. If the management team makes the decision, they must keep in mind that cash can provide enormous flexibility to help you get through difficult times and make the most of opportunities in the future.
Cash is beneficial since there are many ways to use cash are advantageous. Sometimes, grabbing opportunities right now is better than looking for better opportunities. However, sometimes it is not.
