Question

Why do investment-type companies and high-tech companies carry high levels of cash? Is there a cost to holding too much cash?   Is it costly to carry too little cash?

Answer 1

Investment –type companies and high-tech companies carry high levels of cash due to the following reasons:

1. These kind of companies are involved in huge projects and activities that require large amount of funds. To fulfill this requirement Institutions play an important role by coming in as investors to fund these projects. These institutions are on a constant growth path. They are not interested in the annual dividend declared by the company. They would prefer that the company doesn’t pay dividend and retains the cash for growth purposes. In the bargain institutions would also grow simultaneously.
2. These big companies do not restrict their operations to one country. Their operations are spread globally. Any company going global will be subject to transfer pricing norms. So if a company has a subsidiary in a foreign country it will need to hold cash to fulfill its taxation obligations in that country.
3. Since these big companies have huge cash balances, these companies are attractive for other companies when those companies have merger or take over plans as part of their vision.
4. These big companies have the freedom to hold the cash as compared to the middle size companies without being subject to control of shareholders.

The cost to holding too much cash are as follows:

1)Excess cash held by the company leads to over confidence in taking up huge projects without checking their financial viability or technical feasibility. As a result of this if there is a wrong project that is selected , it could effect the existence of the company itself adversely.

2)When the company is holding excess cash it doesn’t exercise caution in day to day spending.

3)When the companies hold excess cash, they do not analyse and go to the root of the problem to solve it .Instead they use this money to try and find a quick fix solutions to the problems.

4) When these companies hold excess cash, then there is an opportunity cost associated with this decision as the money which has been held by the company could have been invested elsewhere in another project or investment avenue which would have fetched the company returns which it has lost.

Holding too little cash may prove costly due to the following reasons:

1. Lack of cash indicates shortage of working capital . The company does not have funds to finance its day to day operations and meet running expenses like salary , purchase of stock etc.
2. Lack of cash may affect company’s ability to meet its short term financial commitments.
3. Due to shortage of cash the companies end up hiring personnel who are not adequately skilled and knowledgeable and who lack experience because hiring experts with experience would prove to be a costly decision.
4. Lack of money will lead to obstacles in the company meeting its vision and goals.