What it means
Profit is an opinion; cash is a fact. A business can report a profit and run out of money, or report a loss and have cash to spare, because profit is measured on accruals (sales when invoiced, costs when incurred) while cash is what has actually arrived and left.
The cash balance is the fact at a given instant. Several balances coexist.
The ledger balance is what the accounting records say. The bank balance is what the bank says, which differs by items in transit.
The available balance is what can be spent now, after allowing for uncleared deposits, holds and any minimum balance requirements. The forecast balance is what the business expects to hold on a future date after known receipts and payments.
Treasurers work with all four; the reconciliation ties the first two together and the forecast projects the third forward. A business needs a cash balance for three reasons.
Transactions: to pay what falls due before receipts arrive, since the two are never perfectly synchronised. Precaution: to survive an unexpected shortfall, such as a customer's late payment or an equipment failure, without emergency borrowing.
Opportunity: to take a discount for early payment, buy stock at a good price, or act on an acquisition. The appropriate balance depends on the volatility of the business's cash flows, its access to borrowing facilities, and the cost of holding cash (interest forgone or paid) against the cost of running short (penalties, lost discounts, lost suppliers, and at the extreme insolvency).
Companies with large balances face the opposite question. Cash beyond operating needs earns little, and shareholders may prefer it returned as dividends or buybacks, or invested.
Large cash piles attract activist pressure and, in some jurisdictions, tax on undistributed profits. The balance should be a decision, not an accident.
For lenders and analysts, the cash balance is read with the debt. Net debt (borrowings less cash) is the usual measure, since a company with $10 million of cash and $50 million of debt is in the same position as one with no cash and $40 million of debt, other than for the flexibility the cash gives.
A cash balance that is trapped (held in a subsidiary that cannot remit it, or in a country with exchange controls), restricted (pledged as security, held for a specific purpose) or needed to fund a known outflow should be identified and excluded from any assessment of spare liquidity.
In practice
Real-world examples.
Example
A retailer's cash balance peaks in January after the holiday season and troughs in October when autumn stock has been paid for but not yet sold.
Example
A technology company holds $4 billion of cash, mostly in overseas subsidiaries, and borrows domestically to pay dividends because repatriating the cash would trigger tax.
Example
A start-up reports its cash balance to investors monthly alongside its burn rate, giving a runway of 14 months.
Think of it
“Cash balance is the number in your bank account-what you have available right now.
Formula
Calculation
Closing Cash Balance = Opening cash balance + Cash receipts minus Cash payments
Minimum Operating Cash = Largest expected cumulative net outflow over the forecast period before receipts catch up + Safety margin
Net Debt = Borrowings minus Cash and cash equivalents
Worked example. A manufacturer has a cash balance of $310,000 on 1 October. Its 13-week forecast shows, in summary:
- Weekly receipts averaging $220,000 but lumpy: two large customers pay at the end of each month, so week 4 brings $520,000 and weeks 1 to 3 only $120,000 each
- Weekly payments: wages $95,000 every week; suppliers $110,000 a week; rent $40,000 in week 1 and week 9; a quarterly tax payment of $180,000 in week 5; a loan instalment of $60,000 in week 8
Running the forecast for the first five weeks:
- Week 1: opening $310,000 + $120,000 minus ($95,000 + $110,000 + $40,000) = $185,000
- Week 2: $185,000 + $120,000 minus $205,000 = $100,000
- Week 3: $100,000 + $120,000 minus $205,000 = $15,000
- Week 4: $15,000 + $520,000 minus $205,000 = $330,000
- Week 5: $330,000 + $120,000 minus ($205,000 + $180,000) = $65,000
The balance falls to $15,000 in week 3 and $65,000 in week 5: the business will not run out, but with almost no margin. A single large customer paying a week late in week 4 would take the balance to minus $190,000 in week 4. The finance manager acts: she agrees an overdraft facility of $250,000 as a standby; asks the two large customers whether they can pay mid-month rather than month-end (one agrees, moving $200,000 from week 4 to week 2); and sets a policy minimum cash balance of $150,000, below which discretionary payments are deferred and the facility is drawn.
With the customer's earlier payment, the week-3 low point becomes $215,000, above the minimum; but week 5 still falls to $65,000 because of the tax payment, so she also arranges to pay the tax in two instalments (weeks 5 and 7), which keeps week 5 at $155,000. The facility remains undrawn. Net debt at 1 October: loan $900,000 minus cash $310,000 = $590,000; the new facility, undrawn, adds headroom without adding debt.Case study
Seen in the real world.
A profitable engineering consultancy with revenue of $6,000,000 ran out of cash. Its accounts showed a profit of $500,000 for the year and a healthy balance sheet, but the partners had drawn their profit shares in full, the firm had taken on two large contracts with payment on completion, and a tax payment fell due in the same month as the partners' quarterly drawings. The cash balance, which nobody forecast because the firm had always had money, went from $400,000 to minus $80,000 in six weeks, and the bank bounced a payroll run.
The firm survived on a hastily arranged overdraft at a punitive rate and a delayed payment to its landlord, and the partners put back $150,000 of their drawings. The finance manager, hired after the event, introduced a weekly cash balance report with a 13-week forecast, a minimum balance policy of six weeks' payroll, milestone billing on all contracts over $100,000, and a rule that partner drawings were paid only from cash above the minimum.
Two years later the firm had a standing balance of $700,000, a committed facility it had never used, and a partners' meeting that began each month with the cash forecast rather than the profit figure. The senior partner's summary was that they had been a profitable firm that nearly failed because nobody's job was to know how much money was in the bank next Friday.
Watch out
Common mistakes.
- Judging liquidity from the balance sheet cash figure, which is a single date, rather than from a forecast of the balance through the coming weeks.
- Treating all cash as available. Restricted, trapped, pledged or committed balances should be excluded.
- Holding a large balance by default without deciding what it is for, or holding almost none and relying on receipts arriving on time.
Questions
People also ask.
What cash balance should a business hold?
Enough to cover the largest expected gap between payments and receipts in the forecast period plus a margin, taking into account any committed borrowing facilities. Many small businesses use two to three months of fixed costs as a rule of thumb.
Why is the ledger cash balance different from the bank balance?
Timing differences: items recorded by the business but not yet processed by the bank, and vice versa. The bank reconciliation explains them.
Does a large cash balance mean a company is doing well?
Not necessarily. It may reflect under-investment, cash raised and not yet deployed, or funds held for a known obligation. Read it with net debt, cash flow and the company's plans.
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