Managing Cash Balances by Considering Business Strategy and Cash Flow Patterns

In financial accounting, cash and cash equivalents are the most liquid components of the statement of financial position. Cash management is a primary concern in financial statement analysis because cash reflects a company’s liquidity capacity and financial flexibility. From an accounting perspective, holding excessive cash also involves opportunity costs and commitment costs, as cash provides very low returns. Furthermore, cash is often likened to the ‘blood’ of a company; without sufficient liquidity, a company may face difficulties in funding daily operations or responding to economic crises. However, determining exactly how much cash to hold is not a simple task.

Using data from non-financial companies listed on the Indonesia Stock Exchange (IDX) for the period 2017 to 2022, the study shows that corporate cash holdings decisions are influenced not only by financial ratios but are also heavily determined by chosen business strategies and the company’s life-cycle phase. Business strategy is fundamental to superior performance in adapting to the environment. The business strategy chosen by management has implications for funding requirements. Business strategies can be categorised into two extremes: prospector companies and defender companies. Prospector companies are characterised by innovation, aggressiveness in seeking new opportunities, high R&D and SG&A ratios, rapid sales growth, and high product change intensity. Defender companies are characterised by efficiency, stability, a focus on operational cost efficiency, product stability, a more dominant fixed asset intensity, and risk minimisation.

Cash and cash equivalent balances in prospector companies are higher than those in defender companies. The prospector strategy has a statistically significant positive effect on cash holdings. Based on agency theory (Jensen & Meckling, 1976; Jensen, 1986), management possesses information asymmetry compared to investors. For prospector companies, management chooses to accumulate larger cash reserves as a form of discretion to maintain financial flexibility. Innovation activities and market expansion involve high levels of uncertainty. Adequate cash facilitates the funding of research projects and expansion without immediate reliance on capital markets or new debt. Additionally, the activities of prospector companies are characterised by high volatility in operating cash flows. High cash balances serve as a liquidity buffer to mitigate the risk of innovation project failures.

Cash flow patterns (cash flows from operating, investing, and financing activities) can be used to classify the company’s life-cycle phase (Dickinson Model, 2011). These cash flow patterns reflect the company’s transformation. The cash requirements of a company with a specific strategy are not always the same over time. These needs transform as the company progresses through four life-cycle phases: introduction, growth, mature, and shake-out/decline. The peak of cash requirements occurs during the growth phase. All life-cycle phases reinforce the drive for prospector companies to hold more cash. However, the order of cash accumulation levels, from highest to lowest, is as follows: (1) growth phase, (2) introduction phase, (3) mature phase, and (4) shake-out/decline phase.

This research provides deep insights for financial accounting practitioners, equity analysts, and auditors in assessing the fairness of a company’s cash balance. For financial accounting practitioners and equity analysts, a high cash ratio or quick ratio in prospector companies during the growth phase should not be immediately dismissed as unproductive excess cash. Such cash balances are part of a strategic reserve to support long-term value creation. For auditors, high cash accumulation grants discretionary power to management, necessitating corporate governance oversight to ensure that retained cash is not used for excessive investments that harm shareholders. The interpretation of cash flow statements should be done integratively by understanding cash and cash equivalents in the statement of financial position and integrating them with cash flow statement analysis to accurately identify the company’s life-cycle phase. Cash policy has no standardised rule applicable to all companies.