Question 10.10: What do you think are the major factors that influence how m...
What do you think are the major factors that influence how much cash a particular busi-ness should hold? See if you can think of five possible factors.
You may have thought of the following:
● The nature of the business. Some businesses, such as utilities (for example, water, elec-tricity and gas suppliers), have cash flows that are both predictable and reasonably certain. This will enable them to hold lower cash balances. For some businesses, cash balances may vary greatly according to the time of year. A seasonal business may accumulate cash during the high season to enable it to meet commitments during the low season.
● The opportunity cost of holding cash. Where there are profitable opportunities it may not be wise to hold a large cash balance.
● The level of inflation. Holding cash during a period of rising prices will lead to a loss of purchasing power. The higher the level of inflation, the greater will be this loss.
● The availability of near-liquid assets. If a business has marketable securities or inven-tories that may easily be liquidated, high cash balances may not be necessary.
● The availability of borrowing. If a business can borrow easily (and quickly) there is less need to hold cash.
● The cost of borrowing. When interest rates are high, the option of borrowing becomes less attractive.
● Economic conditions. When the economy is in recession, businesses may prefer to hold cash so that they can be well placed to invest when the economy improves. In addition, during a recession, businesses may experience difficulties in collecting trade receivables. They may therefore hold higher cash balances than usual in order to meet commitments.
● Relationships with suppliers. Too little cash may hinder the ability of the business to pay suppliers promptly. This can lead to a loss of goodwill. It may also lead to discounts being forgone.