Question

You have heard the saying CASH "not profit" is KING". However in this course, you will read that the goal of the firm is to "MAXIMIZE WEALTH". Does having excess amounts of cash means that the firm has maximized wealthy? Discuss the above statements in light of your understanding of wealth maximization.

Answer 1

Cash "not profit" is "King" simply means that cash really is the king. The saying simply states that it does not matter how much money the firm will make in the future if the company does not have adequate cash to cover its expenses right now (in the present). This means that the firm should generate enough cash to at least cover all its expenses of the present to have a sustainable life in the long run.

There has always been a debate between profit maximization and wealth maximization objectives of a business. The difference between the two objectives is that profit maximization focuses on short term earnings while the wealth maximization focuses on increasing the value of shares and hence increasing the overall value of the business. The wealth maximization is a long-term process and usually requires different strategies to achieve these objectives.

Cash "not profit" is King does say that a company should have adequate cash to run its day to day expenses but a company should not have excess cash as well. A firm having excess idle cash also reduces profit because of the opportunity cost concept. The excess cash of a business can be used in other investments etc which can further increase the profit and also the wealth of the shareholders in the long run. Also, idle cash is like an expense from the financial management point of view because cash has a time value of money. The value of cash decreases overtime in the long run. (The buying power of money changes in the long run)

Therefore, a firm should manage cash in such a manner that the company has adequate cash to run the business and to cover all its present expenses. But on the other hand, there should be excess idle cash that can be invested elsewhere to generate more profit because this can result in wealth maximization in the long run. The company should have optimum idle cash.