Why firms hold cash

Why Firms Hold Cash          

Economist John Maynard Keynes suggested three main reasons why firms hold cash. The three reasons are for the purpose of speculation, precaution, and transactions. All of these three reasons arise from the necessity of companies to possess liquidity.

Speculation                                               

According to Keynes, speculation for holding cash is seen as creating the ability for a firm to take the benefits of special opportunities. These opportunities, if acted upon quickly, tend to favor the firm. An example of speculation is purchasing extra inventory at a discounted rate. This rate is usually far greater than the carrying costs of holding the inventory.

Precaution

A precaution serves as a protectionist or emergency fund for a company. When the cash inflows are not received according to expectation, cash held on a precautionary basis can be utilized to satisfy the short-term obligations for which cash inflow may have been sought for.

Transaction

Firms either create products or they provide services. The offer of services and creation of products results in the necessity for cash inflows and outflows. Firms may hold enough cash to satisfy their cash inflow and cash outflow needs that arise from time to time