Motives to hold cash: Transaction, Precautionary, Speculative & Compensating

“Holding cash is uncomfortable, but not as uncomfortable as doing something stupid.” –Warren Buffett

In a competitive business world, you always want to utilize your resources as much as possible. Cash stands as one of the confusing resources when there is an issue of holding it. There is always an opportunity cost as you have the opportunity to do something else rather than keeping it idle. But then you always remember the last time when you did not hold the cash. So, today we are going to talk about why we tend to hold cash even if there is a cost of holding it.

Motives to hold Cash

There are four common motives to hold cash. Let’s get through it!

Transaction Motive:

An effective operating business has to make day-to-day transactions that may involve cash payments. And those cash payments are very crucial to maintain the functionality of a business.
To maintain operating efficiency, keeping a good liquidity ratio is worthwhile. Because you don’t want to upset your important stakeholders like employees, suppliers.

Timely payment is always appreciatable in the business world. Payment of salaries debts, certain fees, charges or even purchasing supplies timely optimize the business performance. The optimal business operation would not be possible unless you hold an appropriate amount of cash balance.

Cash acts as blood into the daily performance of a business. So transaction motive is one of the most certain reasons to hold cash.

Precautionary Motive

Corona affects every walks of life. Many businesses have been left their operations due to this pandemic. Corona is also a cautionary tale to hold money so that a businessman can fight against unforeseen calamities.
It is really hard to tell what happens to your business no matter how brilliant you are in predicting financial markets. You have to hold some money to get protection against such situations.

Unpredictability pushes businesses to hold cash so that normal operations can not be disrupted due to unfavorable situations.

Speculative Motive

In the business world, opportunity does not come always. When it comes, one must have to snatch it immediately. But a business requires adequate resources to hold an opportunity. Cash is the one most important resource in dealing with speculative situations. If all of your money is invested somewhere else, you might lose a great opportunity that may come out as more profitable and more appropriate.

Suppose, all of a sudden you find a source that provides very cheap materials which price may rise within months. But you don’t have the cash to purchase as your suppliers sell those materials for only cash. So you lose the opportunity. And that’s the reason why a business may hold cash to take opportunities like this.

Managers hold cash to get an opportunity that may arise at any time since the future is not certain. So holding cash paves the way to take beneficial and profitable projects that businesses await to catch.

Compensating Motive

A few days ago one of my colleagues said he could not withdraw all of the cash from his bank account. A minimum balance has to be kept on the account. Though I am describing an individual account situation, a business firm also has to face the same kind of situation.
Sometimes a firm has no choice but to hold cash. Business firms have to maintain a compensating balance that is the minimum balance in a bank account used in offsetting bank charges or any other services provided by the bank. It’s kind of a mandatory situation to hold cash.

These motives have come up when we talk about why a firm holds idle cash rather than investing elsewhere.

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