Why businesses with cash borrow

A few weeks ago I was in a room of financial advisers talking about commercial borrowing. A difficult audience as, the too often heard statement, of ‘my clients have cash’ reared its head as a reason why businesses don’t need to borrow.

The fact remains that businesses with cash and debt are stronger than businesses with no cash and no debt. Cash is the key element, always has been and always will be.

The theory that businesses who hold cash resources don’t need to borrow, or don’t want to borrow is wrong. It is one of the most commonly heard and incorrect lines of thinking, it is also a line of thinking that besets many accountants, financial advisers and business consultants.

Apple Inc

The great example of how cash and debt work together is Apple Inc. Often touted as the most cash-rich company around, if your thinking follows the standard model then you may think that Apple has no need for finance.

This is an extract from their balance sheet;

As at September 2018;

• Apple Inc had $25,913,000,000 in cash or cash equivalent assets
• $131,349,000,000 in current assets
• $93,735,000,000 in long term debt
• $20,748,000,000 in short term debt*

The fact is that businesses with cash resources and cash reserves also borrow.

The Cash vs Debt Model

There are two models we can look at to explain how debt and cash work together. The first looks at the perceived risk of lending and the second at cost and ease of finance.

It is worth noting the relationship between cash and debt in terms of access to borrowing and cost;

This diagram shows how well capitalised businesses are. There is the potential that a business will have excess capital compared to its need, this is often (but not always) the better position to be in. The key is that businesses with cash reserves will be safe but limited by their resources, it is likely that these companies will borrow when required, however by then they will have moved in Q2 or Q4.

The impact on ease of borrowing and cost of borrowing once a business moves between quadrants is detailed in the diagram below;

The summary position is that if you borrow and repay then the cost of borrowing goes down, provided you are not desperate to borrow, in which case the cost rises. If we use the same example as above then the company goes from it being relatively ‘easier’ to borrow to ‘harder’ to borrow and the cost follows upward.

It is a long flaunted point we make, that timing is critical when you borrow and the right time to borrow can often be when you don’t need to cash. It is worth considering when planning ahead.

Cash now doesn’t mean cash tomorrow. Borrowing available now doesn’t mean borrowing available tomorrow.

Food for thought.

By Dave Farmer

*Reference – Nasdaq

*Diagrams are (c) Lime Consultancy 2019