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Auckland Central,
Auckland 1010

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Shortland St
Auckland 1140

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I was recently asked by a client whether they were holding too much cash in the business. My answer was – it depends.

It depends on a number of things as well as the reasons for the cash build up. There are economic, commercial, financial and structural issues to be considered.

As a general rule, having plenty of cash on hand is a good thing particularly for those businesses in cyclical industries such as the resource industry. Such industries can have downturns which can last many years, so having plenty of cash on hand is important. Even if you’re not in a cyclical industry, it pays to have access to cash for a “rainy day”. After all, there’s only one reason businesses go broke and that’s because they run out of cash.

Also, if you’re a fast-growing business you’ll need all the cash you can get your hands on. Cash is king and high growth businesses are in danger territory. Having the necessary cash to fund that growth is crucial.

However, sometimes cash just builds up over time from a prolonged period of profitability. In this case, it begs the obvious question as to the need for the cash, particularly if the cash is simply sitting in a bank account earning nominal interest. To me, this is an obvious sign of a lazy balance sheet. If there is ample cash to fund your working capital needs and there are no obvious plans to use the capital to grow the business then I would argue that the surplus cash should be returned to the shareholders of the business.

If the business is privately owned, the funds can usually be lent back to the business at a later date should the need arise.

Asset protection might be another reason to return surplus cash to shareholders. Leaving the cash in the business means that it is potentially at risk of claims from creditors or other parties. Once it is paid out to shareholders then it is generally no longer at risk in the business.

Having excess cash in a business is just like having a beach house in a business. You wouldn’t do it. Similarly, if you’ve sold a significant asset that is no longer needed and you have cash from the sale that is not needed to fund or grow the business, then it should probably be returned to shareholders who may have a more productive use for the funds.

If you’re actively measuring and managing the financial drivers of the business you’ll soon realise if you’ve got excess cash. This is because you’ll start to experience the symptoms of a “lazy” balance sheet – a falling return on capital employed (ROCE). More cash means you have to make an appropriate return on that. If it’s only earning 2%-3% then your ROCE will start to fall and you should see that trend starting to develop.

More importantly, a “lazy” balance sheet can often lead to other “lazy” practices. If there is ample cash, your team may not be as motivated to chase payment from debtors. As debtors take longer and longer to pay, the risk of default increases which means you may end up with more bad debts. Ultimately, these will come home to roost. Similarly, ample cash may mean your team are not as motivated to maintain appropriate stock levels, which could result in a blow out in inventory.

Sometimes these “lazy” practices manifest themselves into a business threatening culture from which the business may find it hard to recover. The cash stockpile gets run down due to the lax attitude. Couple this with ballooning stock holdings and debtor book and you may encounter a “perfect storm” that you never saw coming and it may be too late to avoid.

So, the appropriate amount of cash to have on hand is all about balance. Not too much, not too little. Keep an eagle eye on your ROCE, working capital burn rate and free cash flow and you should have ample cash to fund the business.