So we’ve all heard that cash is king but do we really understand what this means for our financial planning? Cash has a new found respect in the world due to the recent meltdowns of some the world’s most prominent businesses due to their lack of liquidity. Let’s look at GM for example; GM has been able to run a very successful business for over century yet their lack of cash brought them to bankruptcy. This, as well as countless stories of individuals and big and small businesses we’ve heard in the past two years, should be a lesson to all that when in comes down to it cash is our life line.
What Does Cash Mean?
Cash can mean different things to different people. While some may consider it to be only what they have in their pocket and their checking account other may include the available credit limits from their credit cards in their definition of cash. For our purpose “cash” will refer to any currency you have in the form of coins and bills – including what you have hidden under your mattress – and the balance of your checking and savings accounts. The balance in your checking and saving accounts are excluding any overdrafts and any amounts you owe and are holding to pay back, including any credit card balances.
Why is Cash Important?
Cash is important because it provides individuals and families with liquidity. This means that you are able to pay off your obligations on time even if bad times hit. Let’s consider a couple with only one income and no debts – no credit card balance. I know this may not realistic but let’s be conservative. So what happens if the earning partner is laid off for a couple of months? How will the rent and bills be paid? A couple of options include taking out a short term loan, dip into overdraft protection, use credit cards, or borrow money from family members. However, what is the likelihood of an unemployed couple, even one without any debt, qualifying for a loan. As well, any of these options come with hefty costs – even borrowing from your family members.
Liquidity is also imperative for unforeseen health issues that may arise. For example, for most dental work the patient is required to make payment upfront and is then reimbursed my their insurance provider. If you’ve ever had dental problems you know that when the pain strikes you need immediate treatment. Once again, of course the expenses can be charged to credit cards, etc. However, if there are payment issues from your insurance company, they will not cover your interest charges. Moreover, medical emergencies can be more severe and expensive then this and although we couldn’t possibly be ready for all of life’s misfortunes we can try to combat some.
The importance of cash is aligned with the significance of having an emergency fund. As previously emphasized it is imperative, especially in today’s economy, to have an emergency fund set up. It is equally important to have most, approximately 80%, of your emergency fund in cash or cash equivalent instruments. This allows you liquidity in order to meet obligations even if you are faced with dire circumstances.
How important is cash to you? Do you hold large amounts of cash on hand?
