Idle Cash

What is Idle Cash?

Idle cash is, as the phrase implies, cash that is idle or is not being used in a way that can increase the value of a business. It means that the cash is not earning interest from sitting in savings or a checking account, and is not generating a profit in the form of asset purchases or investments.

The cash is simply sitting in a form where it does not appreciate. In fact, due to inflation, the real-adjusted returns of idle cash may be negative. In other words, not only does idle cash not appreciate, it can actually lose value, due to inflation.

Definition of Cash and Idle Cash

From a purely practical perspective, cash is often defined as physical, legal tender in the form of bills or coins. From a business perspective, however, cash is often classified as cash and cash equivalents. It includes the practical definition above but can also cover cash deposited into a bank account or invested in highly liquid assets such as term deposits.

Based on the definition above, idle cash is most commonly one of the two items below. This list is not exhaustive but provides good examples to demonstrate the concept.

• Physical cash stored in a safe at home or at a business
• Cash deposited into a non-interest bearing account

The Value of Idle Cash

As explained above, idle cash often earns zero or negative value. Let’s take the example of $100 in cash sitting in a safe. This cash is not appreciating as it would in a savings account.

Let’s further assume that the owner of this cash could have deposited it at the bank in a 2% per annum savings account. In a year’s time, that deposit could have earned an extra $2. Instead, the $100 bill is sitting in a safe, earning zero interest. From an absolute perspective, the owner has generated zero value. From an opportunity cost perspective, the owner has actually lost $2 in value.

The negative value of idle cash stems from inflation. Assume that the owner of this $100 bill could buy 50 tennis balls a year ago. This year, the same number of tennis balls will cost him $105 because of the rising price of raw materials. So he not only lost the $2 he could’ve gained in a savings account, but he also lost $5 in purchasing power, for a rough net loss of $7 in value. This is the downside of having idle cash.

Mitigating the Effects of Idle Cash

Despite the potential decline in value, idle cash can easily be turned into a positive investment. As the most liquid of all assets, the owner needs to simply invest the cash in an appreciating asset, or deposit the cash into an interest-generating bank account.

When considering the conversion of idle cash into an appreciating asset, the owner of the cash needs to consider his liquidity needs. Often, a higher interest or appreciation potential will come with lower liquidity.

Checking Accounts

A checking account is the most liquid of bank accounts and allows the owner to withdraw his or her cash at a moment’s notice. It gives the owner the readiest access to his cash. The downside of a checking account is that it often pays the lowest interest rates. In the case of idle cash, however, low interest is better than no interest. Keep in mind, however, that there are checking accounts that pay zero interest.

Savings Accounts

A savings account is the next best account in terms of liquidity. While not as liquid as checking accounts, a savings account will often come with a set amount of free transactions or low fees per transaction. The trade-off for the reduced liquidity is higher interest rates.

High-Interest Savings Accounts

These are similar to a regular savings account, but with higher interest rates. To compensate for the higher interest rates, there may be more limitations on liquidating the cash.

Term Deposits, CDs, and GICs

A term deposit is where the funds deposited are locked in for a period of time. Longer periods equate to higher interest rates paid for the idle cash. Term deposits may also vary between redeemable and non-redeemable, and some redeemable term deposits may have penalties for early redemption.

A CD, or certificate of deposit, is a guaranteed US investment similar to a term deposit. A GIC, or a guaranteed investment certificate, is the Canadian equivalent of a CD. Like term deposits, both CDs and GICs come with lock-in periods during which the funds are not redeemable. These savings vehicles often pay the highest interest rates among the accounts and investments outlined so far.

Stocks and Bonds

The next consideration for using idle cash is to purchase debt or equity. The trade-offs and complexities of these two are many. Stocks and bonds come with higher liquidity than term deposits because they can be liquidated easily or sold in the secondary market. They do, however, have higher risks when compared to savings accounts or saving products.

The trade-off for the higher risk is potentially higher returns, with equity potentially generating the highest return.

Operational Purchases

Finally, business owners hoping to expand their business can also use idle cash. This can be done through purchasing inventory or other short-term assets to support the day-to-day operations of a business. The idle cash may also be put toward the financing of capital or long-term assets such as new machinery or buildings.

The liquidity and returns of capital investments vary, but the benefit of spending idle cash here is that the cash is converted into an asset that either generates revenue or appreciates in value in some manner.

Key Takeaways

Idle cash provides zero or negative value to a business. The upside of idle cash, however, is that it is highly liquid and can easily be converted into an asset that generates positive value. In some cases, there may be strategic merit to holding idle cash. The choice of idle cash or assets depends on an investor’s or business’ strategy.

Related Readings

Thank you for reading CFI’s explanation of Idle Cash. CFI offers the global Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following CFI resources will be helpful:

• Asset Class
• Excess Cash Flow
• Reserve Fund
• Purchasing Power Parity
• Statement of Cash Flows
• See all accounting resources