Cash is king

Cash is king
See also
Capital rationing Capital growth Barriers to entry Reserve capital Frontier market Austrian business cycle theory Free Reserves Business failure Acid-test ratio

"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.

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