Experience is the Difference®

From the time a business opens its doors, the owner is told “cash is king.” It may seem to follow that having a very large amount of cash could never be a bad thing. But, the truth is, a company that’s hoarding excessive cash may be doing itself more harm than good.

Liquidity overload
What’s the harm in stockpiling cash? Granted, an extra cushion helps weather downturns or fund unexpected repairs and maintenance. But cash has a carrying cost — the difference between the return companies earn on their cash and the price they pay to obtain cash.

For instance, checking accounts often earn no interest, and savings accounts typically generate returns below 2% and in many cases well below 1%. Most cash hoarders simultaneously carry debt on their balance sheets, such as equipment loans, mortgages and credit lines. Borrowers are paying higher interest rates on loans than they’re earning from their bank accounts. This spread represents the carrying cost of cash.

A variety of possibilities
What opportunities might you be missing out on by neglecting to reinvest a cash surplus to earn a higher return? There are a variety of possibilities. You could: 

  • Acquire a competitor (or its assets). You may be in a position to profit from a competitor’s failure. When expanding via acquisition, formal due diligence is key to avoiding impulsive, unsustainable projects. 
  • Invest in marketable securities. As mentioned, cash accounts provide nominal return. More aggressive businesses might consider mutual funds or diversified stock and bond portfolios. A financial planner can help you choose securities. Some companies also use surplus cash to repurchase stock — especially when minority shareholders routinely challenge the owner’s decisions.
  • Repay debt. This reduces the carrying cost of cash reserves. And lenders look favorably upon borrowers who reduce their debt-to-equity ratios.

Optimal cash balance
Taking a conservative approach to saving up cash isn’t necessarily wrong. But every company has an optimal cash balance that will help safeguard cash flow while allocating dollars for smart spending. Our firm can assist you in identifying and maintaining this mission-critical amount.
 

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Two puzzle pieces fitting together one with a light bulb the other a dollar signMany companies reach a point in their development where they have to make an important decision: Innovate themselves or acquire a competitor? Of course, it isn’t always an either/or decision. Nonetheless, business owners should consider the pluses and minuses of both approaches.

Innovating to grow

Innovation is a broad term that encompasses many strategies — all of which are intended to help the company achieve goals such as boosting profits, improving cash flow, or diversifying products or services. Common strategies are:

  • Research and development of new products,
  • New market penetration via geographic expansion or enhanced product/service offerings, and
  • Increased productivity resulting from internal improvements or enhancements.

Each strategy takes time, effort and capital. Understandably, business leaders can be hesitant to devote such vital resources to innovation initiatives and risk decreases in productivity and profitability.

Combining companies

For companies that don’t want to bet the farm on internal development, acquisitions can be appealing. If you’re looking to expand a product line, for example, it might be more time- and cost-effective to buy a competitor that already offers the goods you want.

Your acquisition target has already done the hard work — including funding, testing and creating the product or service and building a client base. By buying this competitor, you may incur less risk than you would by investing your own capital and building the product from scratch. The same holds true for geographic expansion and productivity improvements.

But business combinations come with their own risks. To fully benefit from any acquisition, your company needs to “stick the landing” — efficiently integrate operations and retain divisions and employees capable of ensuring that innovations continue to pay off. For many buyers, that’s a tall order.

Considering your options

In an ideal world, companies would devote resources to innovation and also make the occasional acquisition to bolster their standing in particular markets. But most companies don’t have the luxury to do both simultaneously. Please contact us for help examining the risks and potential rewards associated with each option.

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Experience is the Difference®

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