How much cash does a company need?

There is widespread evidence of companies hoarding cash these days.  Given the risk levels in the environment, it is natural for companies to want to keep a little something for a rainy day.  This is especially true for younger, unproven companies and high-tech companies – where the risk levels are higher and the ability to raise funds (in case of a crisis) may be limited.

One study for US companies (quoted here) suggests that the cash-to-asset ratio for companies has more than doubled between 1980 to 2004 – going up from 10.5% to 24%.

You’d think that 24% is a pretty large number as an average – but the report points out that number is skewed by some large companies like Exxon Mobil, GE, Microsoft, Apple, Google, Cisco, Johnson & Johnson, Verizon, Altria, EMC, Disney, Oracle.   Tech companies have an average cash-to-asset ratio of 27%, with Google at a monstrous 58%.

So it’s not necessarily the small, tech startup that’s raising the average (27% vs 24%).  It’s probably the big old economy players.   And I haven’t yet seen evidence of the stock-market punishing them for that (unlike what we read in B-school).  It really seems to be a case of everyone (with the ability to) trying to hoard cash.

Closer to home, Indian IT services firms have been traditional hoarders of cash.  So I did some quick numbers on them.  Even by their standards, the pile-ups seem to be phenomenal.  Between 2006 and 2010, Wipro’s cash/asset ratio has gone up from 13% to 24%.  TCS from 3% to 22%.  Infosys went up from 48% to 51% in 2009 and is now “down” to 44%.

You could argue that cash/asset ratios aren’t the best metrics for a services company – where the risk levels and uncertainty are lower than for product companies.  What you should look at is cash/operating expenses – how many month’s oxygen does a company have if all it’s revenue streams run dry.  There again, Infosys is up from 54% to 71% (about 8 months of expenses).  Wipro from 13-24% (3 months) and TCS from 2 to 21% (2.5 months).

So the question is how much cash does a company really need to keep on its balance sheet?  One could make several arguments about how the big IT companies could do with lower cash reserves (most of them are also quite unleveraged and have pretty significant real-estate assets).  However, it doesn’t seem like the stock market cares much for this ratio – and may actually reward cash hoarding tendencies!  There are many theories out on the subject, but the unifying argument seems to be missing.

Let’s see how things change once the recovery is more certain.. watch this space.