What is a target cash balance?
Are you aware that even though a company aims to earn money, there is such thing as having too much cash? While having too little cash is quite common, have you thought that there is such thing as too much cash? Some may say that this might not be the best idea because of several reasons. Having too much cash on the balance sheet means that there is no excellent opportunity at the moment. For some, it might seem like the management is not competent enough to manage money or find significant expansion or investment opportunities for the company.
The cash on the balance sheet should not be extreme. It should not be more or less, which is why we have a “target cash balance.” It is an ideal amount of cash that a company should have at any time. It balances out the opportunity costs between having too much cash and too little cash on reserve.
A company that holds too much might not only miss opportunities. It might also have crash drags. On the other hand, a company that owns too little might have to resort to insufficient transactions just to make way for more operating capital. Also, a great opportunity might arrive, and it will be forced to turn a blind eye because it does not have sufficient money to go through with it.
Setting up the target cash balance
Setting up a target cash balance is not only ideal for big entities like companies. It is also an excellent idea for individual investors, and they can do it through portfolio management and set financial goals. It will give them an idea about the holding percentage they need to have in cash to avoid problems.
We mentioned that there is such thing as having too much cash on the balance sheet. However, some might beg to disagree because having extra cash means having liquidity during sudden good and bad situations. We have cash reserves for good situations. You can use them when a great opportunity arises. For example, assets suddenly went on sale, and the price is way below the market value. On the other hand, we have rainy funds for less desirable situations such as financial problems and cash flow disruptions.
It’s part of a bigger plan.
A portion of an even bigger strategy goes to the target cash balance. Entities have different target cash balances depending on the economy and market cycle points. What does this mean? Let’s say that a particular sector is timely right now. Many people related to that sector will maintain enough cash reserves in case acquisition opportunities arise. On the other hand, retailers may have a low period and need to operate with a more insufficient target cash balance than usual. In a nutshell, it targets cash balances that can change depending on different factors, conditions, and opportunities. It also depends on various factors involving an industry or a company and fund options availability.