Many non-financial companies have on their balance sheet short-term assets in the form of cash and cash equivalents. This cash can be used to cover short-term loans, pay dividends, buyback shares, settle with suppliers, pay taxes, etc.
Companies may also have short-term income-generating investments. As a rule, these are highly liquid securities that can be sold and converted into cash during a trading session. Cash, their equivalents and short-term investments can be grouped into the Total Cash group.
Excess cash is the amount of cash beyond what the company needs to perform its daily operations. Excess cash is generated when total current non-cash assets fully cover total current liabilities.
All initial data for calculation are in the balance sheet of annual or quarterly financial reports of non-financial companies.
The formula for calculating excess cash is as follows:
The formula for calculating total cash is as follows:
The formula for calculating total current non-cash assets is as follows:
Let’s calculate the excess cash for 3 companies: Boeing Co, Apple Inc and Nike Inc. The data are taken from the annual financial statements for the fiscal year 2018. The unit is $1 million:
|Boeing Co||Apple Inc||Nike Inc|
|Cash and Cash Equivalents||$7,637||$25,913||$4,249|
|Total Current Assets||$87,830||$131,339||$15,134|
|Total Current Liabilities||$81,590||$116,866||$6,040|
|Total Current Non-cash Assets||$79,266||$65,038||$9,889|
Please note that Nike Inc has all the total cash in excess, because the total current non-cash assets fully cover the total current liabilities.
- Act as an airbag. Cash may be needed by the company to cover current liabilities, interest payments or other unforeseen expenses. Excess cash allows to survive during the difficult economic times;
- May indicate competitive advantage. The fact that there is excess cash means that the company is capable of making money beyond need. If the excess is large, the company probably has a consumer monopoly. For such a company should look more closely;
- May be spent on dividend payments or further growth. The board of directors may pay out excess cash in the form of dividends or spend it on the expansion of production. Thus, excess cash will serve to increase the intrinsic value of the company;
- Act as a discount when buying a company. For example, you buy a company with excess cash of $300 million and debts of $50 million. You pay $1 billion for the transaction. In fact, you paid $750 million because you got access to excess cash, compensating part of the amount spent by $250 million after paying off debts for $50 million.
- Require management. Cash is subject to inflation and requires competent management for their saving and growth. A company can invest in itself or in other businesses and financial instruments;
- Can lower return on assets. Excess cash can lie on the balance sheet without generating income. If return on assets, excluding excess cash, is 15%, and return on excess cash is 10% or even 0%, then the total return on assets will be lower;
- Management may misuse them. Often, excess cash provokes the self-confidence of the board of directors, which can begin to take destructive decisions for business. For example, unprofitable acquisitions of other companies or financing of knowingly unprofitable lines of business.
Excess cash requires attention and competent management. If the profitability of short-term investments is lower than the business profitability, then it is better to invest excess cash in your own business or to pay to shareholders in the form of dividends.
If there are debts, you should also pay attention to the debt interest rate at which the company pays for the use of borrowed funds. If it is higher than the yield of short-term investments, then it is worth considering the repayment of borrowed funds by the amount of excess cash in full or in part.
Investors use excess cash when calculating indicators such as Enterprise Value, Return on Investing Capital, etc.