What are cash reserves?
Cash reserves refer to cash that a business or individual keeps to meet short-term and emergency financing needs. Short-term investments that provide customers with quick access to their money, often in exchange for a lower rate of return, may also be referred to as cash reserves. Examples include money market funds and Goods of treasure (Goods of treasure).
Key points to remember
- Cash reserves refer to cash that a business or individual keeps on hand to meet emergency financing needs.
- Very liquid short-term investments, such as money market funds and treasury bills, may also be referred to as cash reserves.
- Cash reserves are useful when cash is needed immediately for a large purchase or to cover unexpected payments.
- Hoarding too much money is often detrimental, as the money can usually be put to better use elsewhere.
How Cash Reserves Work
Having large cash reserves gives an individual, group of individuals, or business the ability to make a large purchase immediately. It should also ensure that they are able to cover themselves when they go through a difficult time financially and have to make sudden and unexpected payments.
Companies
Businesses hold cash reserves to meet all planned and unforeseen costs in the short term, as well as to finance potential investments. Money is the most liquid form of wealth, but in the short term assetslike three months Goods of treasure (T-Bills), are also considered cash reserves due to their high liquidity and short term. due dates.
Some companies, including Alphabet Inc. (GOOGL), Apple Inc. (AAPL) and Microsoft Corp. (MSFT), currently have billions in cash reserves. Needs vary, but in general experts recommend companies have three to six months exploitation charges tied up in cash or highly liquid assets.
business america held $1.69 trillion in cash at the end of 2018, according to a Moody’s Investors Service report. This amount is down 15% from the record high of $1.99 trillion at the end of 2017, before the Tax Cuts and Jobs Act took effect.
Banks
The banks are subject to requirements on the amount of cash reserves they must hold, as mandated by the United States Federal Reserve (Fed). This amount is determined as a percentage of deposit liabilities, called net transaction accounts, which is, in fact, the money that individuals and businesses place in banks and must be repaid at some point in the future.
The Reserve ratio on net transaction accounts depends on the size of the net transaction accounts with the custodian institution.
Image by Sabrina Jiang © Investopedia 2021
These reserves must be held in the form of vaulted cash or deposits in a Federal Reserve Bank. Since December 27, 1990, non-personal term deposits and euro currency the liabilities are not subject to any cash reserve requirement.
Important
When the economy needs a boost, the Fed sometimes lowers reserve requirements to encourage banks to lend more.
People
Individuals are advised to have enough money in reserve to last at least three to six months in case of an emergency. They hold their cash reserves in bank accounts or in stable short-term investments that are not likely to lose value. This way, they can withdraw those emergency funds or sell those investments at any time without losing money, regardless of how the stock market performs.
An individual’s cash reserves may consist of cash in a current accountsavings account, Money market fundsWhere money market accountas well as short-term Treasury bills (T-Bills) and certificates of deposit (CD). Individuals and businesses that do not have sufficient cash reserves may resort to credit or, in extreme cases, be forced into bankruptcy.
Disadvantages of Cash Reserves
Sitting on a lot of money sounds good, right? Not always. Having cash reserves can be useful when there is cash flow problems and money is needed for something immediately. However, it is important to strike the right balance as too much can be detrimental.
Hoarding excess cash can lead to missed opportunities. Higher returns could have been generated by reinvesting some of that extra money back into the business. In theory, the amount of money that these investments generate in revenue should easily exceed the rates paid by a checking account.
For individuals, keeping too much money in cash reserves can also be detrimental. Yes, they are safer. But they also generate far lower returns than, for example, investing in stocks, bonds, REITs, gold, alternative assets, or diversified portfolios of any asset class. Over the years, this difference becomes very noticeable due to inflation and the power of the time value of money composition.