Why do you need to hold cash? (4 Main Reasons)

Cash is still considered the most liquid asset. Cash is common denominator to which current assets such as- account receivables, inventories will also be converted at the end. Cash is required to purchase raw materials, equipment, other assets which are required to provide products and services for businesses. Marketable securities such as- stocks, bonds, commercial paper, T-bills and money market instruments are also can be converted into cash in a quick manner. The term cash not only limited into cryptocurrencies, coins, currency notes, cheques, bank drafts but also the marketable securities as mentioned earlier. 

In a narrow sense, cash only consider the physical money namely notes and coins. But in a broader sense, anything which is highly liquid can be considered as cash, for example- Fixed deposits in bank, short term investment, etc.

It is pivotal to know why we need to hold cash.

There are various reasons to hold cash. Among them, there are four important motives can be taken into account when we want know the reason for holding cash.

1. Transaction Motive: In order to purchase raw materials and pay for bills and operating expenses we need to hold cash. It is crucial to meet the daily need of business operations to maintain a constant growth for the entity.

2. Precautionary Motive: We never know what is going to happen in the next moment. In order to meet the unexpected events of future it is essential to hold cash. The examples can be:

• Natural disaster, labour strikes, opt out of bona fide customers
• Bills which might be required to settle earlier than the scheduled period
• Failure to collect account receivables or not able to collect the full amount
• Customers cancellation of ordered goods due to dissatisfaction or changes of mind
• Hike of prices in raw materials

3. Speculative Motive: This is one of my favourite reason for holding cash. It has the following merits:

• It provides an opportunity to purchase raw materials when the prices are low
• Purchasing securities when interest rates are low and get high return from there
• Due to anticipating that raw materials price will be declined in near future we can hold cash and wait for the drop of the prices
• Committing purchases at any favourable condition which will give return

4. Compensating Motive: Last but not the least, this is considered another motive of holding cash balance in order to compensate banks which provided loans and services to the business.

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