WCM/U2 Topic 1 Meaning of Cash, Motives for holding Cash
Cash is the most liquid asset a company can own. A company’s cash account in its chart of accounts includes all currency and coins owned by the company as well as all deposits in the bank including checking accounts and savings accounts. Cash also includes instruments or contracts that can be deposited in a bank account like vendee checks, customer checks, cashier’s checks, certified checks, as well as money orders.
The cash account, like all asset accounts, is a debit account. This means that debit or left entry in the cash account would increase the cash account. A credit entry would do the opposite.
Cash is recorded as a current asset on the balance sheet. Even though cash can be saved for future periods, it is still considered a current asset because it can because it can be used in one period. Long-term assets like vehicles cannot be completely used during one accounting period.
Since balance sheets display current and long-term assets in order of liquidity, cash is always the first item on a balance sheet. Many times companies combine cash and cash equivalents on the balance sheet. Since cash equivalents are closely related to cash, the true meaning of the cash account is not distorted on the balance sheet.
If a company overdrafts its checking account, it technically has no cash and actually owes the bank money. In this case, a negative cash balance is usually not displayed as a current asset. Instead a cash overdraft is presented as a current liability.
Motives for holding Cash
The Motives for Holding Cash is simple, the cash inflows and outflows are not well synchronized, i.e. sometimes the cash inflows are more than the cash outflows while at other times the cash outflows could be more. Hence, the cash is held by the firms to meet the certain as well as uncertain situations.
Majorly there are three motives for which the firm holds cash
The transaction motive refers to the cash required by a firm to meet the day to day needs of its business operations. In an ordinary course of business, the firm requires cash to make the payments in the form of salaries, wages, interests, dividends, goods purchased, etc.
Likewise, it also receives cash from its sales, debtors, investments. Often the firm’s cash inflows and outflows do not match, and hence, the cash is held up to meet its routine commitments.
The precautionary motive refers to the tendency of a firm to hold cash, to meet the contingencies or unforeseen circumstances arising in the course of business.Since the future is uncertain, a firm may have to face contingencies such as an increase in the price of raw materials, labor strike, lockouts, change in the demand, etc. Thus, in order to meet with these uncertainties, the cash is held by the firms to have an uninterrupted business operations.
The firms hold cash for the speculative purposes to avail the benefit of bargain purchases that may arise in the future. For example, if the firm feels the prices of raw material are likely to fall in the future, it will hold cash and wait till the prices actually fall.
Thus, a firm holds cash to exploit the possible opportunities that are out of the normal course of business. These opportunities could be in the form of the low-interest rate charged on the borrowed funds, expected fall in the raw material prices or favorable change in the government policies.
Thus, the cash is the most significant and liquid asset that the firm holds. It is significant as it is used to pay off the firm’s obligations and helps in the expansion of business operations.