What Do Businesses Do with Their Cash?

by Oct 15, 2020Practice Finance

“This is a picture of a real bill. The $500 bill featured President William McKinley. It was discontinued in 1969.”

In order to stay in business, companies need to make money and hopefully turn a profit.

If they are profitable, what do they do with their cash?

This is an important concept to understand for multiple reasons, especially for investors considering investing in a particular company (or its stock).

Let’s go through 7 things companies can do with their cash.

Do they create more value for their shareholders? Or do they have a history of destroying their wealth?

Note: it is no coincidence that some of the following thoughts also apply to individuals! And it also applies to vet clinics!

1. Nothing

Sitting on their cash is a valid strategy. A business may want to buy a competitor or make a particularly costly purchase in a few months. Some companies would rather pay in cash than take on additional debt. Alternatively, the cash can be used as a downpayment to reduce the size of the loan.

2. Spend

Of course, some companies spend like there’s no tomorrow. They build new headquarters. They buy new business cars. They buy a company jet. They put their name on a sports arena. They buy season tickets. They give gigantic raises or stock options to the happy few.

3. Debt

Some companies strive to repay their debt early (hopefully without a prepayment penalty). This needs to be figured out based on multiple factors, one of which is the interest rate.

4. Reinvest

Companies can reinvest in their own business. They can update their equipment (computers, phone system, software). They can also provide more training to their employees.

5. Grow

When your account is flush with cash, you can open new stores or new factories. You can buy other companies to grow yours. You can buy new equipment. You can offer new services. You can hire more employees and managers.

6. Dividends

Some companies choose to pay a dividend to their shareholders. Think of it as giving cash as a bonus simply for being an investor.

The dividends can be paid monthly, quarterly or annually. There are even “special dividends,” which are paid literally as bonuses.

7. Repurchasing

If they have cash and their stock is reasonably priced, companies can decide to buy their own shares to “artificially” increase their price. If they buy at a low price (i.e. at a discount), then it can be a very powerful strategy that rewards shareholders.

Studying what a company (or an individual) does with cash tells you a story. Actions count more than words. Believe it, and act accordingly.

Phil Zeltzman, DVM, DACVS
Meredith Jones, DVM
Co-Founders of Veterinary Financial Summit