How is cash on hand calculated?

Beyond the Balance Sheet: Understanding Your Company’s Days Cash on Hand

In the fast-paced world of business, understanding your company’s financial health is paramount. While profit margins and revenue growth often take center stage, one crucial metric often overlooked is “Days Cash on Hand.” This seemingly simple calculation offers a powerful insight into your company’s short-term solvency and its ability to weather unexpected storms.

What is Days Cash on Hand?

Days Cash on Hand (DCOH) is a liquidity ratio that measures how long a company can continue to pay its operating expenses using its readily available cash and cash equivalents. It’s essentially a snapshot of your company’s runway – how much time you have before running out of fuel.

Think of it like this: imagine your car’s gas gauge. You want to know how much further you can drive before needing to refuel. Days Cash on Hand tells you a similar story for your business, indicating how many days your current cash reserves can sustain your daily operations.

Calculating Your Runway:

The formula for calculating Days Cash on Hand is straightforward:

Days Cash on Hand = (Cash & Cash Equivalents) / (Average Daily Operational Expenditure)

Let’s break down each component:

• Cash & Cash Equivalents: This represents the readily accessible funds your company has available. This includes:

  • Cash: Physical currency in hand and funds held in bank accounts.
  • Cash Equivalents: Highly liquid investments that can be easily converted into cash within a short period (usually three months or less). Examples include short-term government bonds, treasury bills, and money market funds.

• Average Daily Operational Expenditure: This represents the average amount of money your company spends each day to keep the business running. This is where it gets a little more nuanced. You need to calculate this figure based on your operational expenses, excluding non-cash items like depreciation and amortization.

  To calculate Average Daily Operational Expenditure:

  1. Identify total operational expenses: This usually involves reviewing your income statement and identifying expenses directly related to running the business (e.g., salaries, rent, utilities, marketing, cost of goods sold).
  2. Exclude non-cash expenses: Subtract expenses like depreciation, amortization, and stock-based compensation. These don’t represent actual cash outflows.
  3. Calculate total annual (or relevant period) cash operational expenditure.
  4. Divide the total by the number of days in the period (usually 365 for annual figures). This gives you your average daily operational expenditure.

Why is Days Cash on Hand Important?

A healthy Days Cash on Hand figure is crucial for several reasons:

• Indicator of Liquidity: It provides a clear picture of your company’s short-term financial health and its ability to meet its immediate obligations.
• Buffer Against Uncertainty: A comfortable DCOH acts as a buffer against unexpected expenses, economic downturns, or delays in payments from customers.
• Negotiating Power: Companies with strong cash reserves often have more negotiating power with suppliers and lenders.
• Investment Opportunities: Adequate cash on hand allows you to seize attractive investment opportunities that may arise.

Interpreting the Results: What’s a “Good” Number?

There’s no one-size-fits-all answer to what constitutes a “good” Days Cash on Hand. It depends on several factors, including your industry, business model, and risk tolerance.

• Industry: Some industries, like manufacturing, require larger cash reserves due to higher operating costs and longer production cycles. Other industries, like software-as-a-service (SaaS), may operate with lower DCOH due to recurring revenue streams.
• Business Model: A business with predictable, recurring revenue can often operate with a lower DCOH than a business with volatile sales.
• Risk Tolerance: A more conservative company may prefer to maintain a higher DCOH to provide a larger safety net.

As a general guideline:

• Less than 30 days: Could indicate a tight cash flow situation and potential vulnerability to unexpected disruptions.
• 30-60 days: A moderate level, but should be monitored closely.
• 60-90 days: Generally considered a healthy and comfortable level for many businesses.
• Over 90 days: Might indicate an overly conservative approach, as excess cash could be used for more productive investments. However, certain industries or companies preparing for acquisitions might need such a large cushion.

Conclusion:

Days Cash on Hand is a vital metric for understanding your company’s short-term financial health. By regularly calculating and monitoring this ratio, you can gain valuable insights into your company’s liquidity, its ability to withstand unexpected challenges, and its overall financial stability. Don’t let this crucial indicator fade into the background – proactively manage your cash flow and ensure your business has the runway it needs to succeed.

#Accounting #Balancesheet #Cashflow