Some people may think it is a good thing when a public company hoards cash. Main

Question

Some people may think it is a good thing when a public company hoards cash. Maintaining large cash balances on their balance sheet looks good to many people. In some cases, these cash rich companies have cash balances exceeding their total debt.

Why do some companies hoard cash?

If a company is hoarding cash instead of using it, how does this affect (either positive or negative) investors, employees, creditors, the community, and the economy as a whole?

As an investor, would you prefer that a company continue to hoard cash? If not, what other uses of cash would you like to see as an investor?

Explanation / Answer

Step 1 : why do some companies hoard cash?

Some investors seek out companies which has plenty of cash on their balance sheet. This is because cash offers protection to company against tough times. Hoarding of cash also gives companies more options for future growth. Companies requires enough cash to cover their interest, expenses and capital expenditures and little bit in case of emergencies.

Step 2 : Negative effects of Hoarding cash

The current ratio and quick ratio help investors determine whether companies have enough coverage to meet near time cash requirements. Any extra cash over and above these levels should be redistributed to stockholders either through dividends or stock buybacks.

Higher levels of the cash on balance sheet can frequently signal danger ahead. Hoarding of too much cash results in opportunity cost, which amounts to the difference between the interest on holding cash and price paid for having the cash as measured by the company's cost of capital. If the project's return is less than the company's cost of capital, the cash should be returned to shareholders.

The hoarding of too much cash also results in slow growth of the company which ultimately affect the investors, employees, creditors, the community and the economy as a whole.

Step 3 : Other uses of cash

As an investor, I would not prefer a company that continue to hoard cash because as discussed in step 2, hoarding of cash has many negative effects. The excess cash should be invested in different type of short term and long term securities. The major part of cash can be used for expanding the business of company which can result in higher future returns.

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