Nothing like cash
How much cash do you have in your pocket right now? Silly question, right? Who carries cash anymore? Isn't it much better to have your cash invested in higher-yielding opportunities? But wait — if you needed more cash today or tomorrow — are you sure you could get it?
This reality is why the conventional wisdom and theory on about corporate finance and cash is being turned tested. This lesson applies to all companies, whether you employ 1 person or 1 million.
Bill Gates prefers to have cash on hand to last a year with zero sales. He is in good company — the Economist notes that many large companies, especially founder-led companies like Apple and Google — maintain large cash positions.
Conventional corporate finance theory (if you want the nitty-gritty, check out the Modigliani-Miller theorem) suggest that the value of a firm does not depend on how it is financed — you can use a mixture of debt and equity and the total enterprise value is unaffected. So many companies, pressured by institutional investors, load up on debt, which is tax-deductible, compared to equity, which is not. Companies are also pressured to return cash to investors through dividends or share buybacks.
But what happens when you are unable to refinance the debt due to a credit crisis like we are seeing now? I think most of us would prefer to have some cash sitting around to weather the storm.
How much cash do you need to maintain? Enough to weather a downturn and/or to finance a shift in your business model. If your business model is in flux, your sources of capital will be limited or at the very least, quite expensive.
As most entrepreneurs understand, the best time to raise capital is when you don't need it. Getting a slight incremental return on your cash is not worth the lost peace of mind of being able to have it when you really need it.
