Is Excess Cash Slowing Down Your Growth? (2024)

Managing cash efficiently involves overseeing incoming and outgoing funds. Business owners should ensure they have enough liquidity to cover daily operations and short-term liabilities, so it's sensible to keep some cash at hand.

But how much cash should a business hold? Is it ok to have surplus cash?

Understanding the Concept of Surplus Cash

While it's usually beneficial for businesses to have cash available, they can sometimes amass too much. Surplus cash is the extra cash a business has beyond what it needs to cover its immediate expenses. Business owners are often well aware of issues of not having enough cash, but the potential issues of excess cash are not usually considered. Excessive cash can detrimentally affect a company's performance in various ways. If large cash balances persist on the company's balance sheet, investors may question why this capital isn't being utilised more effectively.

How Can Surplus Cash Affect Your Business's Expansion?

An ongoing high level of cash on a company's balance sheet may signal financial mismanagement. It might indicate inefficient cash management, a lack of investment opportunities, or uncertainty regarding what to do with surplus funds.

Holding onto surplus cash can be an expensive indulgence that can adversely impact the company. It incurs an opportunity cost, representing potential earnings the business could have achieved through investment. Adequate decision-making can help capitalise on these opportunity costs.

Surplus cash can have three negative consequences:

1. It can reduce your return on assets. Surplus cash that isn't needed for business operations is unproductive. This cash could instead be invested in income-generating projects.
2. It can elevate your cost of capital. This represents the expenses a company incurs to acquire its assets, either through borrowing or using its cash. While the cost of borrowed funds equates to the interest payment, the cost of using cash is less apparent. However, a company's return on assets should exceed its cost of capital; if not, it's likely gradually heading for insolvency.
3. It can escalate business risk, diminish value, and lead to overconfidence in management. When managers believe they can do no wrong because they have an abundance of cash, they can become overconfident. Excess cash might reflect past business success, but it doesn't indicate future potential. Instead of resolving business problems, management may use surplus cash to conceal mistakes. Additionally, management often shifts from a proactive growth mindset to a reactive decision-making mode when there's an abundance of cash. Companies with excess cash often overpay for acquisitions, reducing the company's market value.

Putting Your Surplus Cash to Work

Firstly, pay off any debts. It's nonsensical to pay unnecessary interest on debt, especially when your return on assets is lower than the interest you're paying. Secondly, ensure that all projects inside the business are adequately funded and that there are no other projects that could be pursued. Finally, if all debt has been repaid and all investment projects inside the business are funded, consider investing the cash outside the business in a tax-efficient way.

More information:

• Get our free report on how to prepare your business for exit so it sells for the highest valuation possible:here.
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