What it means
The definition is deliberately narrow. Cash holdings include current accounts, instant access deposits and very short term instruments such as treasury bills, but exclude money the business cannot actually reach, such as balances pledged as security or held in escrow, which are disclosed as restricted cash.
Businesses hold cash for three broad reasons: to meet day to day timing differences, to cushion against unpleasant surprises, and to be ready to act when an opportunity appears. Companies with volatile cash flow, few borrowing options or large uninsured risks rationally hold more than steady, well banked ones.
The cost of holding cash is real but easy to overlook. Money sitting in a low yielding account while the company also pays interest on borrowings is a straightforward loss, which is why many groups run sweep arrangements that move surplus balances against the overdraft automatically.
Investors watch cash holdings closely, and their view depends on context. A large balance in a company with clear investment plans reads as prudence, while the same balance in a business with no plan for it invites pressure for a special dividend or a share buyback.
The most useful way to express holdings is in time rather than dollars. Stating that the business holds three months of operating costs communicates far more to a board than a raw balance, and it automatically scales as the company grows.
In practice
Real-world examples.
Example
A cruise operator holds nine months of operating costs in cash because a single safety incident or travel restriction can stop bookings almost overnight. Its board treats the balance as insurance rather than idle money. Shareholders who pressed for a special dividend were shown the modelled effect of a three month suspension of sailings.
Example
A utility with regulated, predictable revenue and a committed credit line holds less than one month of costs. Its cash flow is steady enough that a large buffer would simply reduce returns for shareholders. The undrawn facility does the job a cash pile would do at a fraction of the cost.
Example
A family owned engineering firm accumulates $4,000,000 over several strong years with no stated purpose. At the annual review the shareholders agree to split it between a machinery upgrade and a one off dividend rather than let it sit earning almost nothing. The discussion only happened because the finance manager expressed the balance as eleven months of operating costs.
Think of it
“Cash holdings are how much cash you keep on hand-your liquid reserves.
Formula
Calculation
Cash to total assets = Cash and cash equivalents / Total assets, and Months of cash cover = Cash and cash equivalents / Average monthly operating cash outflow
A speciality chemicals company holds $12,000,000 in cash and equivalents against total assets of $80,000,000. Its cash to total assets ratio is $12,000,000 / $80,000,000 = 15%, which is comfortably above the 5% to 10% typical of asset heavy manufacturers.
Average monthly operating cash outflow is $4,000,000, so months of cover is $12,000,000 / $4,000,000 = 3 months. The company also carries $20,000,000 of borrowings, so its net debt position is $20,000,000 - $12,000,000 = $8,000,000, which is the figure a lender will focus on rather than the cash balance alone.Case study
Seen in the real world.
This is an illustrative and entirely fictional story. Aldermere Instruments, an invented maker of laboratory equipment, had built up cash holdings of $9,000,000, equal to about seven months of operating costs, after several profitable years. The founder found the balance reassuring and resisted every suggestion to deploy it.
The board asked for a proper analysis rather than a debate about instinct. It showed the company faced fairly steady demand, held a committed and undrawn $3,000,000 facility, and had monthly cash flow that varied by only about 8%, all of which pointed to a genuine requirement closer to three months of cover.
Aldermere's fictional directors set a target holding of $4,000,000, used $2,500,000 to repay a term loan carrying 7% interest while the cash earned 2%, and committed $2,500,000 to a new calibration facility. The interest saving alone was worth about $125,000 a year, and the company remained comfortably funded.
Watch out
Common mistakes.
- Counting restricted cash, escrow balances or deposits pledged to a lender as though they were freely available.
- Holding large cash balances at the same time as paying interest on borrowings, when repaying debt would earn a certain and better return.
- Judging the balance in dollars alone rather than as months of cover, which makes it impossible to tell whether it has kept pace with the size of the business.
Questions
People also ask.
How much cash should a business hold?
A common starting point is three to six months of operating costs, adjusted upwards for volatile cash flow and downwards for committed and reliable credit facilities.
Are cash holdings the same as working capital?
No, working capital covers stock and receivables and payables as well, while cash holdings are only the money already in accessible accounts.
Does a big cash pile mean a company is safe?
Not on its own, since it must be read against debts falling due, committed spending and how quickly the business consumes cash each month.
From the founder's library
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