Idle cash as the phrase suggests, is cash that is idle or not being used in a way that can increase the value of a business. It means that the cash is not earning interest from sitting in savings or a checking account. It does not generate profit in the form of asset purchases or investments. The cash is simply sitting in a form where it does not appreciate but depreciates in value due to inflation.
From a purely practical perspective, cash is often defined as physical, legal tender in the form of bills or coins. Then from a business perspective, cash is often classified as cash or its equivalent. Based on the above definition, idle cash is most commonly demonstrated in the following concepts:-
- Physical cash stored in a safe at home or at a business.
- Cash deposited into a non-interest bearing account.
Having defined what idle cash is let’s take a look at its value.
Idle cash often earns zero or negative value. Let’s take the example of Ksh. 10,000 in cash sitting in a safe; this cash is not appreciating as it would in a savings account. Let’s further assume that the owner of this cash could have deposited it at the bank in a 2% per annum savings account. In a year’s time, that deposit could have earned an extra Ksh. 200. Instead, the Ksh. 10,000 bill is sitting in a safe earning zero interest. From an absolute perspective, the owner has generated zero value. From an opportunity cost perspective, the owner has actually lost Ksh. 200 in value.
The negative value of idle cash stems from inflation. Assuming that the owner of this Ksh. 10,000 bill could buy 20 tennis balls a year ago. This year, the same number of tennis balls will cost him Ksh. 10,500 because of the rising price of raw materials. So he not only lost the Ksh. 200 he could’ve gained in a savings account, he also lost Ksh. 500 in purchasing power, this is the downside of having idle cash.
Mitigating the Effects of Idle Cash
Despite the potential decline in value, idle cash can easily be turned into a positive investment in the following ways:-.
- As the most liquid of all assets, the owner needs to simply invest the cash in an appreciating asset, or deposit the cash into an interest-generating bank account. When considering the conversion of idle cash into an appreciating asset, the owner of the cash needs to consider their liquidity needs. Often, a higher interest or appreciation potential will come with lower liquidity.
- A checking account is the most liquid of bank accounts and allows the owner to withdraw his or her cash at a moment’s notice. It gives the owner the most ready access to his cash. The downside of a checking account is that it often pays the lowest interest rates. In the case of idle cash, however, low interest is better than no interest. Keep in mind, however, that there are checking accounts that pay zero interest.
- A savings account is the next best account in terms of liquidity. While not as liquid as checking accounts, a savings account will often come with a set amount of free transactions or low fees per transaction. The trade-off for the reduced liquidity is higher interest rates.
- The next considerations for using idle cash are to purchase debt or equity. The trade-offs and complexities of these two are many. Stocks and bonds come with higher liquidity than term deposits because they can be liquidated easily or sold in the secondary market. They do, however, have higher risks when compared to savings accounts or saving products. The trade-off for the higher risks is potentially higher returns, with equity generating the highest as compared to bonds.
- Lastly, business owners hoping to expand their business can also use idle cash. This can be done through purchasing inventory to support and run the day-to-day operations of a business. It may also be putting the idle cash toward the financing of capital or long-term assets such as new machinery or buildings. The benefit of spending idle cash here is that the cash is converted into an asset that either generates revenue or appreciates in some shape or form.
As shown above, idle cash provides zero value to a business. The upside of idle cash is that it is highly liquid, and can easily be converted into an asset that generates positive value. In some cases, there may be strategic merit to holding idle cash. The choice of idle cash or assets depends on an investor’s or business’ strategy.