How Important is it to Have Cash on Hand? I'm sure that you've heard the adage "cash is king" at some point. But, where exactly did that phrase originate from? And, what exactly does it mean? Well, the origin isn't crystal clear. But, falling the 1988 global stock market crash, it was used by Pehr G. Gyllenhammar, who was the Chief Executive Officer of […]The post How Important is it to Have Cash on Hand? appeared first on Due.
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I'm sure that you've heard the adage "cash is king" at some point. But, where exactly did that phrase originate from? And, what exactly does it mean?
Well, the origin isn't crystal clear. But, falling the 1988 global stock market crash, it was used by Pehr G. Gyllenhammar, who was the Chief Executive Officer of Volvo at the time. "Cash is king" was also used frequently throughout the global financial crisis in 2008. And, it's certainly been thrown out during the time of coronavirus.
Have you noticed a theme here?
How Important is it to Have Cash on Hand?
During times of uncertainty, cash, without question, reigns supreme. The reason? It's the most valuable liquid asset an individual or business can possess.
Liquidity is being able to meet your obligations without taking without incurring a loss. In other words, you can still carry out basic economic actions. I'm talking about buying, selling, paying off your debt, or putting food on the table without using a credit card or taking out a loan.
With that in mind, cash on hand is merely the total amount of any accessible cash. Obviously, this includes the literal money you have in your pocket, safe, or under the mattress. It also covers any liquid asset that can be quickly converted into cash — usually within 90 days. These include;
- The amount you have in a checking or savings account.
- Money market assets.
- Marketable equity securities (stocks).
- Marketable debt securities (bonds).
- U.S. Treasuries.
- Mutual funds.
- Exchange-traded funds (ETFs)
- Items you own ranging from clothing to jewelry
- Accounts receivable.
Having these liquid assets can give you peace of mind by reducing financial stress. And, they can help bail you out in case of financial hardship. But, why else is cash on hand so important for businesses and individuals?
The importance of cash on hand for businesses.
There are several underlying factors why a business can go bankrupt. Market conditions, poor decision making, financing, and especially a lack of profitability are all to blame.
While having cash on hand may not solve all of your business's problems, it definitely can help for the following reasons — and some tips on how to make this possible.
1. Maintain a positive cash flow.
"Cash flow, or the measure of the amount of money being transferred in and out of your business, can ultimately make or break your organization—regardless of how profitable your business is on paper," explains Peter Daisyme is a previous Due article. "While conceptually simple, launching and executing a cash flow management strategy can be tricky even for financially experienced organizations."
But, just how big of a deal is cash flow? Peter argues that it matters more than revenue.
"It's hard to say that cash flow matters 'more' than revenue since both are defining financial metrics for your organization," he adds. "However, revenue and even your net profit can be high while cash flow suffers—and if your cash flow creeps too far into negative numbers, you may never fully recover."
As such, you should make tracking and increasing your cash a priority. Some suggestions would be to designate a cash flow manager, limit expenses, and increase revenue. When you do, cash flow won't be as tight, and it will increase your ability to make even more money.
2. Can help your business scale.
If you want your business to grow or expand, then you're going to have invested in it. I'm referring to upgrading your technology, purchasing property, or hiring new employees. Often, these are one-time purchases. So, it makes more sense to use your existing assets instead of taking out a loan or line of credit and being stuck paying back interest for years to come.
Furthermore, you can also grow your business by acquiring another. Sometimes this can happen seemingly overnight. And, you can be certain that other business owners are also eyeing this prized possession. Without having immediate access to the funds to buy a valuable company, you might miss out on the opportunity.
3. You're able to pay bills on time.
I can tell you from personal experience that this juggling act can be stressful. Let's say that your phone bill is due on the 18th of the month. The problem? It's the 15th and a client still hasn't paid you. Even worse? You don't have enough money to cover the bill.
If you miss this payment, you're going to be slapped with a late fee. Your service may also get turned off. And, let's not talk about those sleepless nights as you worry about paying your bills.
Having cash on hand not only reduces financial stress and anxiety. It also ensures that you'll avoid unnecessary late fees because you paid the bill on time.
4. Reduce transaction (and security) costs.
For small businesses, in particular, it's imperative that you keep your costs as low as possible. One way to achieve this is by eliminating payment processing fees from wire transfers, credit/debit cards, or gateways like PayPal. The most glaring starting point is only to accept cash payments.
If that isn't completely possible, you can at least lower payment processing fees. You can do so by:
- Choosing a low-fee payment processing system.
- Factoring these fees into your pricing.
- Negotiating a lower fee.
- Accepting multiple forms of payments to balance out these fees.
There's another perk to accepting only cold, hard cash. You're lowering your cybersecurity risk. Considering that small organizations (those with fewer than 500 employees) spend an average of $7.68 million per incident, this should be on the top of your mind.
5. Allows you to meet emergencies.
"Emergencies are not a matter of if; they are a matter of when," states Amanda Abella in another Due piece. Everything from natural disasters, equipment/system crashes, legal issues, or medical emergencies that aren't covered by insurance are lurking around the corner. "That's why business owners need to know how to financially prepare for emergencies."
"Business owners can't rely on a paycheck hitting their bank account every two weeks," adds Amanda. "If they aren't working, they aren't making money. If a hurricane takes you out for a week or longer, you've lost a lot of money."
"Bills do not stop because of" an emergency like a hurricane or global pandemic. "While your mortgage company may give you a short forbearance (and that's a big maybe), other service providers probably won't," she states. "The truth is we're often on our own financially after emergencies and that's where savings can help."
6. Ensures surviving an economic downturn.
As we're continuing to witness, external factors like COVID-19 can lead to an economic downturn. While this figure will probably increase, as of August 31, 2020, Yelp reported that "163,735 total U.S. businesses on Yelp have closed since the beginning of the pandemic."
Even if you're able to reopen, which I hope you are, you may have to adhere to new guidelines from organizations like the CDC. For example, cleaning and disinfecting the building, installing a new ventilation system, or putting up plexiglass dividers.
Having cash on hand can give you a lifeline during these turbulent times. It can also help you adapt without putting yourself into debt.
The importance of cash on hand for individuals.
Cash on hand doesn't just apply to businesses. It's also necessary for the average Joe or Jane.
1. It's liquid.
The best thing about cash, or any other liquid asset you own, is that it's there when you need it. For instance, you might have been furloughed because of the pandemic. Is your 10-year Treasury bond going to pay for rent, groceries, or other necessary expenses?
The answer is a resounding no. While U.S. Treasury bonds should be a part of your portfolio to had stability, you can't touch it until it matures. That makes it useless when you're in a pinch.
2. Keeps your investments diversified.
"Diversification is an investment strategy where you own a variety of assets that will perform differently over time," clarifies Due Founder and CEO John Rampton. "The idea is that it provides security and mitigates risk. If an investment fails or underperforms, you won't lose everything."
At the same, "a diversified portfolio shouldn't contain too many options," adds Rampton. "Diversification is a protection against ignorance," said Warren Buffett. "[It] makes very little sense for those who know what they're doing."
And, yes, liquid assets like cash should certainly be a part of your diversified portfolio as it provides security and stability.
3. Gives you psychological peace of mind.
"If you've invested for at least 10 years, you have been through a stock market decline," states Barbara Friedberg, MBA, MS, author of How to Get Rich; Without Winning the Lottery. "It hurts. It's painful to watch your portfolio value decline." Even worse? Having "to sell assets after a decline because you need the money."
"The psychological medicine of holding cash can’t be underestimated," adds Friedberg. "Imagine how you would feel, even if you don't need any of the money in your investment portfolio for a long time if you saw the S&P 500 index drop 20 percent or 30 percent, and you didn’t have any cash in your portfolio."
"This type of experience causes fear to take over, and investors to feel like they must 'do something,'” she states. "And usually, doing something involves selling stocks at the bottom."
4. There are still cash-only transactions.
For the last month, I've been self-disciplined enough not to get takeout. I finally decided to treat myself to pizza last weekend. After I called in my order, I remembered that my favorite pizzeria is still cash-only.
Thankfully, I had cash in the house. If not, I would have had to hit up a nearby ATM. Not the end-of-the-world. But, that would have defeated the purpose of getting delivery.
While cash-only businesses aren't as prevalent as they once were, a whopping 83% of small businesses claim that they will always accept cash.
Another advantage? Using cash to make smaller purchases, ensures that you stick to your budget or cave to impulse purchases. For instance, if you want to the grocery store with $50 to spend and that's all the cash you have, then that's it. But, if you have your credit card, you might make impulse purchases.
5. Helps you avoid interest and fees.
If you recall, businesses are responsible for late fees. You are as well. So, if you're a freelancer, and a client has paid you, you cannot pay your bills. And, if you don't have a cash cushion to get you by, expect to be penalized.
Moreover, when you have cash available, you won't have to rely on plastic or take a loan. As a result, you're avoiding debt, as well as those hefty interest rates and. And that may even damage your credit score.
If you use your card, like when buying plane tickets, at least you have the money to pay off the balance.
6. Covers the unexpected.
Life is full of surprises. Some pleasant. Others? Not so much. And, it only gets worse when you don't have an emergency reserve to handle these unexpected expenses.
In fact, even just $1,000 set aside would suffice.
"Our research suggests that keeping a cash buffer greatly reduces the risk that a family will miss a payment for rent, mortgage, or a recurring bill, will be unable to afford enough food, or will be forced to skip needed medical care within the next six months," writes Emily Gallagher, assistant professor of finance at the University of Colorado Boulder and a research fellow at the Federal Reserve Banks of St. Louis and Philadelphia.
If you don't have this buffer, you may fall into debt or even withdraw funds from your retirement account because you lost your job or had a medical/dental emergency. In fact, Americans have racked up $45 billion in medical debt.
But, it's just not emergencies that are unforeseen. There will be times when costs may be higher than anticipated. Case in point, getting a quote on a car repair or redoing your home's bathroom.
You could have been told it would cost $1,000. But, it ends up costing you an additional $600. Having cash on hand won't make this a stressful problem.
How much cash on hand should you have?
It's often advised that you should have between 3 to 6 months of living expenses in an emergency fund. So, if you need $3,000 to cover your most important expenses, think mortgage, utilities, and food each month. That means you'll need at least $9,000 saved.
But, that will increase depending on other factors. If you're married and have three children, then you'll need even more cash on hand. Money Under 30 has a handy emergency fund calculator to help determine how much you should have saved.
But, what about business owners?
"For companies, the amount of cash they should hold depends on their industry’s cyclicality, the overall strength of their balance sheet, and their funding needs," explains Matthew DiLallo for The Motley Fool. "Companies in highly cyclical industries with weak balance sheets and large capital spending programs should carry more cash than those in stable sectors, with strong balance sheets and limited capital needs."
"Cash also gives these companies the flexibility to make acquisitions or other investments during periods of market turmoil," he adds. "Investors need to keep those things in mind when looking at a company’s cash balance."
I know that's not helpful if you were looking for an exact amount. But, I think you should take DiLallo's advice and figure this out with a financial advisor.
And, if you're struggling to save cash, start out small. If possible, put $100 a month to the side. Within a year, you'll have $1,200. That might not sound like much. But, it's without question better than having no cash on hand.
Image Credit: alexander mills; pexels; thank you!
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