Is There Such a Thing As Too Much Cash?
Yes. It’s rare, but when it happens it costs you money.
Having too much cash is one of those nice-to-have problems like being too smart or too handsome. It looks like it’s all upsides until you dig deeper.
Cash Costs You Money
In all businesses cash comes in two forms:
Debt:
Money you borrow from the bank,
Money you borrow from the shareholders,
Cash advances from sharks like Cash4Less (don’t even think about it),
Issuing debt in the form of bonds, promissory notes, etc. Unless you are a large corporation looking to raise hundreds of millions this is not an option.
Equity: The equity comes in two forms:
Invested capital from your shareholders
Retained earnings or net income your company has decided to keep in the business for future growth.
All these sources of cash come at a cost:
Debt:
Bank loans: interest and fees
Shareholder loans: interest
Cash advances: ridiculous amount of interest
Issued debt: coupon payments, which are effectively interest
Equity:
Invested capital: returns in the form of dividends and stock appreciation
Retained earnings: the cost of missed opportunities.
Okay, but are these costs real?
They are as real as money coming out of your bank account. They show up on your P&L and it’s real money you pay to creditors and investors.
Usually, the cost of capital is not an issue for a healthy business. This is because the expectation is that the business will use the capital to generate even more money than the cost of debt and equity.
When things are not going well, however, cost of capital becomes a major issue.
Cash pushes you to spend
Having access to vast amounts of cash pushes companies to spend on things that don’t bring any real value. Sam Bankman-Fried bought a $35M mansion in the Bahamas to turn into a head office for FTX. Adam Neumann had an in-office vegan chef during his days at WeWork. Recently, a friend of mine came back from a lavish company retreat in Prague.
But not all spending is extravagant and overtly wasteful. Startups securing large investments fall victims to the pressure to spend fast, grow fast and drive higher valuations fast.
The vast amounts of VC money that flowed to startups during the COVID years caused overhiring. When the promised growth didn’t materialize, the pendulum swung the other way and companies started the layoffs we are seeing today.
The point is, equity comes with expectations. Sometimes they push companies to sacrifice quality decision-making for speed of capital deployment.
How can you tell you have too much cash?
After you’ve accounted for working capital, a cash reserve for emergencies and cash to fund your strategic growth plans, you’re left with the excess.
What do you do with the excess cash?
You can do three things:
Invest it income-generating securities (stocks, bonds, etc.)
Pay it out to your shareholders as a special dividend
Buy back shares
Which option you choose (and they’re not mutually exclusive) will depend on your unique situation.
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