We’ve all heard this one singular phrase in business over and over again. In fact, I’ve heard it so many times it hurts for me to even mention it. It makes me cringe just because it has been beaten into my head so many times. “Cash is King”. There, I said it. I said it only because it is true. “Cash is King”. What does that even mean? It means this, he who holds the cash can rule freely, sort of.
Advantages
Sitting in a strong cash position as a business owner does several good things for your business. First, it puts you in the driver seat, with full control of your business. If a business owner has enough cash to run daily operations, buy new assets, and pay their vendors then for all intensive purposes, they don’t need to borrow money. If a business owner does not need to borrow money then they don’t have to abide by the rules laid out by any lenders or vendors. Typically, a lender (usually the bank) will enforce covenants and monitoring on a business any time there is a significant amount of money lent to this business. What amount constitutes as significant is dependent on which bank you are with and how much you have borrowed. Not having to worry about what any lender wants you to do allows you to roam the business world freely.
Second, vendors like working with businesses with lots of cash. As a business owner carrying around a big bag of cash, perks suddenly find their way towards you, especially when purchasing new assets. Nothing sounds better to a seller’s ear than “I will be paying with cash.” Paying a vendor with cash has several positive effects for the vendor. If you as a business owner pay with cash, the vendor doesn’t have to worry about you overdrawing on your line of credit, not getting approved for the new loan, or worse yet stiffing them with the bill and not ever paying them back. For these reasons, vendors generally prefer to deal with buyers paying with cash. In fact, all things being equal, meaning both buyers are willing to pay the same price, the vendor will side with the cash paying buyer almost every time. And as if it is not enough that these businesses have wads of cash lying around, vendors generally offer incentives and discounts for paying with cash. The rich get richer.
And third, having enough cash to cover all of your major expenses, plus a little on the side for a rainy day, makes for a very good night sleep. Most business owners don’t like to talk about this sort of thing, but borrowing money all of the time is very stressful. Not knowing where your next round of payroll is coming from can take years off of a business owner’s life. He who holds the cash can rule freely and without worry.
Disadvantages
This is a tough sell. Are there disadvantages of paying for your equipment with cash? They do exist. While 9 times out of 10 you would pay cash if you have it, a smart business owner must always consider the opportunity cost of the cash outlay. An opportunity cost is the benefits you could have received by choosing an alternative action. In the case of using cash to buy equipment, one must consider what else could have been purchased with that same cash. And could whatever else was purchased generate a higher return on your investment than the equipment. Instead of earmarking that cash to buy the equipment a business owner should ask themselves:
- Can I expand my business by opening a new store?
- Can I have pay off higher interest bearing debt?
- Can I increase my sales force?
- Can I invest that cash in a marketable security and earn a higher rate of interest than I would pay in lease interest?
These are valid and realistic questions to ask yourself before deciding to lay down a couple hundred thousand dollars on a new piece of equipment. Always consider what could have been used with that money, the true opportunity cost.
One other consideration that should be mentioned is that when purchasing a new piece of equipment with cash, you are paying up front 100% of the assets value. In reality, the piece of equipment won’t “pay you back” or earn you revenue equal to it’s purchase price for, most likely, a few years, this is called the payback period. If you were to finance the equipment, the monthly payment would most likely match, be above or near to the value the piece of equipment is adding to your business on a monthly basis. Thus evening things out a little more.
