How do business compute what is the optimal cash holdings ? I came across this fascinating research report (Why do Companies Hold Cash?,Gianni La Cava and Callan Windsor) that examines the question of why companies hold cash and illustrates the level of cash in Australian companies being high relative to world standards. The report shows that for the period 1990–2014 Australia is 2nd in the world with approximately 25% of total assets held in cash for Non Financial Corporations.

It would appear that a sort of correlation exists between relative high cash holdings with a positive view on future investment opportunities. In this case, the wonderful Tobin’s Q is used as a proxy to represent forward looking indicator of the company’s outlook for investment opportunities. Simply put, in the period under review, businesses were building cash reserves to spend on exciting investment opportunities.

Fast forward just a little bit to 2017 and seemingly that investment in new opportunities has not quite materialised with Deputy Governor Guy Dubelle in the speech entitled Business Investment in Australia illustrating that non-resource investment has been weak due to low growth demand. So what do corporates then do with their relative high cash holdings in a low interest environment.

The rates outlook for deposits remains subdued and the major banks are lowering deposit rates even further with the variance now between the major banks and the other banks often exceeding 100%. This means that savings rates available with non-major banks paying more than double those at the majors.

The conundrum for business is then how to allocate assets to deliver an appropriate return when almost 25% of the assets are delivering a return barely in line with inflation. Does this imply that the other 75% of business assets are offering far superior returns to compensate for this? And what does this reflect on future investment opportunities. Have these exciting investment opportunities remained in place to explain the relatively high cash levels or are other factors and risk avoidance determining asset allocation? Does this research reflect the reality for your business? What is your ideal allocation?

Current data for non ASX listed companies are not easy to compile and it would be interesting to extrapolate this insight across the broader market. Do other business also have high cash holdings and what would they be earmarked for ? If you wish to share you views, we welcome you to either comment or share your thoughts.