Cash is king

"Cash is King" has become a widely used term in the world of finance and investment, despite having an uncertain origin, it has been used by major figures in the investment world in recent decades, figures such as Warren Buffett , Pehr Gustaf Gyllenhammar and Alex Spanos.

The term "Cash is King" is generally used to refer to the holding of cash, which translates into liquidity, by companies and investors.

The debate

As usual, this type of strategy has positive and negative consequences, as well as advocates and attackers.

• The main argument of the advocates of "Cash is King" is that the possession of cash and liquidity makes it possible to invest quickly at times when the stock market falls, taking advantage of opportunities for good prices, allows rapid investment in, for example, machinery for companies without the need to resort to debt and also makes it more difficult for the company to go into receivership.
• On the contrary, the attackers claim that the large amount of cash can mean a holding of idle resources on the part of the company or the investor due to its continuous decline in value caused by inflation.

Real world

Especially during the last few years and after the 2008 crisis, large companies such as Apple and Amazon have carried out a process of accumulating cash on their balance sheets. This large accumulation of cash by these companies has allowed them to make large outlays to make purchases, invest in Research and Development (R&D), expand as a company and especially to have a "cushion" in times of crisis.

However, large accumulations of liquidity are a double-edged sword. In the same way that they provide great solvency and liquidity for the investor or for the company in the short term, they can also pose a risk in the long term, since not only does the value of this cash decrease over time due to inflation rates, but there is also the opportunity cost associated with the possible profits and benefits that the investor or company could acquire if they used this money in some kind of investment.

It is precisely at this point when the need to find a balance between cash accumulation and cash expenditure appears. This balance is not the same for all companies, but is determined mainly by the economic sector in which they operate, their size and their business planning for the long term. A clear example of this difference on the part of companies is the aforementioned size of the companies, since according to Kalcheva (2007), large companies tend to demand less cash due to economies of scale. It has also been shown that large companies tend to have a lower demand for cash due to their greater capacity for financial innovation and the lower cost of external financing.

It is clear that the concept of "Cash is King" can be more complicated than it may seem at first, as it is subject to many small nuances, therefore, we will refer to the words of one of the great figures of investment and already mentioned above, Warren Buffet. Warren Buffet usually comments that he always operates with high levels of liquidity, even higher than what he might need in very adverse circumstances, since, as he himself says, "this is what allows him to sleep at night without worries". He also often mentions that precisely this cash "cushion" allowed him to take advantage of the falling prices of the 2008 financial crisis. Despite all this, he himself has on occasion described liquidity as "the worst investment you can have" mainly due to inflation rates.

As mentioned above, over the past few years there has been an increase in the level of cash in large companies, an increase for which analysts and investors have tried to give a more concrete explanation. These behaviors, as expected, have generated great criticism and opinions.

• One of them refers to the fact that the fall in the average period of CEOs in that position, causes them to carry out a more conversational business policy and strategy in order not to disappoint profit expectations in the short term.
• On the other hand, other investors and strategists point to a different explanation, believing that companies are not investing as much because investment opportunities are scarce due to a global context of low growth.

After trying to find some of the possible reasons why companies are carrying this accumulation of liquidity, it is inevitable to look for the consequences not only internally, but also externally. This increase in the accumulation of liquidity, and therefore a decrease in investment, has social and political as well as economic consequences. From a social and political point of view, this type of strategy could be questioned, since the decrease in investment could lead to less job creation and less technological progress. From an economic perspective, there is the opportunity cost to shareholders of companies maintaining high liquidity.

There is a vision which argues that liquidity can be of great value as a strategic asset, as mentioned in the research note "Cash is suprisingly valuable as a strategic asset". In this research note, the idea of "Defensive strategy" appears, which as Porter said, "seeks to reduce the probability of receiving an attack, reduce the number of possible attackers or reduce their intensity". After mentioning this concept, it is easy to understand how a possession of ample liquidity that allows a fast and flexible mobilization of resources in uncertain conditions, can be interpreted by the competition as a sign of being a company with a great capacity to defend itself against possible threats.

Final conclusion

In conclusion, we can say that the "Cash is King" concept is more complex than it may seem. This concept has given rise to great debates and, as is often the case in the world of finance and investment, there is no exact formula for dealing with this problem. The accumulation of liquidity can be a great advantage for the company or investor in times of bear markets, but in the same way during times of great economic growth it can be an idle resource devalued by inflation. It could be considered that depending on the investment strategies, the size of the company, the global macroeconomic situation and the long-term vision of the company or investor, an optimal balance of liquidity level could be found, but taking into account that this is very complicated to calculate.

Examples of Cash is king

• Warren Buffett has famously said "cash is king" to describe his investment philosophy. He believes that having a large amount of cash on hand is a key element to successful investing since it allows investors to take advantage of opportunities when they arise.
• Pehr Gustaf Gyllenhammar, former CEO of Volvo Group, also endorsed the idea of "cash is king" when he famously said "cash is the only thing that matters in the long run". He believed it was important to be disciplined and to maintain a healthy cash position in order to remain competitive.
• Alex Spanos, the founder of A.G. Spanos Companies, also embraced the concept of "cash is king". He believed that having a large amount of cash on hand was essential for any business to remain competitive and successful. He also believed that having cash on hand allowed businesses to take advantage of opportunities when they arose.
• In the world of investing, the term "cash is king" is often used to refer to the importance of having a large amount of cash on hand. This allows investors to take advantage of opportunities when they arise, such as buying stocks when prices are low. It also allows investors to have a cushion to fall back on in case of unexpected costs or losses.

Advantages of Cash is king

Cash is King is a popular phrase in the world of finance and investment, and has been used by many leading figures in the investment world. It is a reminder that cash is an important asset, and there are a number of advantages to having it in your portfolio. The main advantages of having cash are:

• Flexibility and Liquidity: Cash is the most liquid asset, meaning it can be easily exchanged for goods and services, or converted into other forms of investments. Cash can also be used to take advantage of opportunities as they arise, such as investing in stocks during a market downturn.
• Lower Risk: Cash is generally the least risky form of investment, as it is not subject to market volatility or the risk of default. It can also provide a buffer against losses in other investments.
• Diversification: Including cash in your portfolio can help to diversify your investments, reducing the overall risk.
• Returns: Cash does not usually generate large returns, but it does provide a regular, low-risk return. This can be especially beneficial in a low-interest rate environment.

Limitations of Cash is king

Cash is King is a widely used phrase in the finance and investment world, however it has some limitations that should be taken into consideration. These include:

• The lack of liquidity of cash investments. Cash investments may not be easily convertible into other assets, meaning that investors may be unable to access their money quickly in the event of an emergency.
• The lack of potential for return. Cash investments are usually not high yielding, meaning that investors may not be able to achieve the same returns as they would from other forms of investment.
• The potential for inflation risk. Cash investments may not keep pace with inflation, meaning that the value of the investment may decrease over time in real terms.
• The lack of diversification. Cash investments are usually held in a single asset class, meaning that investors may not be able to benefit from the diversification benefits of other types of investment.

Other approaches related to Cash is king

Cash is king has become a widely used phrase in the world of finance and investment. There are several other approaches that can be applied in order to maximize returns on investments and ensure financial stability. These include:

• Investing in low-risk, high-yield financial instruments such as Treasury bills and bonds: Such investments can provide a steady stream of income without the risk of principal loss.
• Diversifying investments: Diversification involves spreading investments across different asset classes, thus minimizing the risk of losses due to fluctuations in a specific asset class.
• Building an emergency fund: Setting aside a portion of funds to be used exclusively in case of an emergency can help prevent an unexpected financial crisis.
• Investing in stocks: Stocks offer the potential for higher returns than many other investments, but they also involve a higher degree of risk.
• Creating a budget: Creating a budget can help ensure that funds are allocated appropriately and that expenses are kept under control.

In conclusion, cash is king may be an important part of an investment strategy, but it is not the only approach that should be considered when attempting to maximize returns and minimize risk. Other strategies, such as investing in low-risk, high-yield financial instruments, diversifying investments, building an emergency fund, investing in stocks, and creating a budget, can all help to ensure financial stability and maximize returns.

Footnotes

Cash is king — recommended articles

Capital rationing — Appropriation of retained earnings — Translation Risk — Capital buffer — Cross margining — Funding Operations — Capital Base — Defensive strategy — Reserve capital

References

• Kim,C. (2014). Cash is suprisingly valuable as a strategic asset. "Institutional Knowledge at Singapore Management University"
• Kinnunen,R. (2015). Is cash still king?. "Lund University School of Economics and Management".
• Lazonick,W. (2014). Profits Without Prosperit. "Harvard Business Review".

Author: Alejandro Román