Businessman Investor

Touching base with the rational business psyche of stock market investors

Friday, August 19, 2011

The Corporate Cash Hoard Theory

This is Part 1 of a Series.

Ultimately, the industrialists, the rich, or the wealthy want to see a certain build-up of cash profits (i.e. free cash flow) in their businesses. This is despite all the demand of large cash outlays to maintain their respective core business operations. They try to achieve and maintain this liquid financial state so they can pay themselves (e.g. dividends, share buybacks) or further reinvest those free cash in other cash-generating assets (e.g. acquisitions of whole businesses, non-core business investments). Like a small seed growing into a large fruitful tree, small humble businesses, producing hoards of cash, turn themselves into large holding companies owning several other businesses. These subsidiary businesses, which eventually produce even more cash themselves, enable the corporate group to acquire even more businesses, compounding wealth at an accelerating speed.

Uncle Scrooge McDuck's Cash Hoard. While the word "hoard" or "hoarding" evokes images of wealth and riches in the forms of gold coins, jewelries, and other valuable/rare items, in the real world of business, these are in the forms of cash, investments in real estates, ownership of businesses/stocks, bonds, and other liquid, marketable assets or other cash-generating assets.
This hoarding nature of excellent, money-making companies can be attributed to their unwaning generation of free cash flow which has accumulated in the midst of the enterprise. Its accumulation, thus, would indicate a business well positioned to propel itself, as it utilize those hoarded free cash to exploit shareholder value-enhancing opportunities.

I will be discussing a self-contemplated financial concept I shall be referring to as “Corporate Cash Hoard” or simply, “cash hoard”, “free cash hoard”, or “free cash equity”. It is a theory which picks up from where the idea of free cash flow left. It is not intended to replace your usual standard accounting/finance balance sheet framework (particularly familiar accounts such as current assets, non-current assets, current liabilities, non-current liabilities); what it intends to offer is a cash-bias perspective on the overall “free cash” financial standing of a firm.

Before you continue reading, I’d suggest you read through my Cash is King blog series. That’s gonna help provide some basic understanding and, hopefully, useful insights on how to visually observe how a business internally generates its cash profits.

The concept of the corporate cash hoard is founded on the idea that: With free cash flow being continuously produced by a cash-generating business, it’s got to be accumulating somewhere in the balance sheet. The question is, where have all those free cash flow gone? Thus, although I would refer to it as “cash hoard”, this shouldn’t be confused with the cash & cash equivalents asset account under the balance sheet. Continue to Part 2: So Where Have All Those Free Cash Flow Gone?

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The information presented here is for educational purposes only. Under no circumstances should it be construed as a recommendation to buy, sell, or hold any stocks. If you choose to use this information, you do so at your own risk.

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