What is the Target Cash Balance
The target cash balance describes the ideal level of cash that a company wishes to hold in reserve at any given point in time. This figure hopes to strike a balance between the investment opportunity costs of holding too much cash and the balance sheet costs of holding too little. Companies with excess cash on hand may be missing out on investment opportunities, while companies that are cash poor can often be forced to make otherwise undesirable transactions to free up more operating capital.
BREAKING DOWN Target Cash Balance
It is wise for individual investors to set their own target cash balance as well. Through portfolio management and clearly defined financial goals, investors can at least approximate what percentage of their holdings should be in cash to avoid the pitfalls listed above.
Under most scenarios, excess cash balances offer a buffer for unexpected events, both good and bad. A "rainy day" fund can help offset the financial distress brought on by unplanned cash flow disruptions. While a cash reserve can also help seize timely investment opportunities that surface unexpectedly, such as a competitor suddenly closing their doors and selling their assets below market value.
The target cash balance is often part of a larger investment or business strategy. Various industries will maintain different target cash balances depending on where the economy is at on different points in the market cycle. For instance, when technology is hot, larger tech players will maintain a healthy cash reserve for acquisitions. In contrast, retailers may be experiencing a lean period and will operate with target cash balance below normal levels.
Target cash balances will fluctuate based on economic conditions and opportunities, factors unique to the industry or company, and the availability of funding options. During an easy money monetary environment, maintaining elevated levels of target cash balances is less costly.