Idle cash or idle money as the name implies is the cash that is sitting idle, means it is not earning any income. Such cash (also known as barren money) that is not earning income in the way of interest, dividend, asset purchase, etc. may gradually lose its value over time due to inflation.
Idle cash is neither deposited in an interest-bearing instrument or nor does it participate in the economic markets. Many also call such cash as ‘waste’ money as it does not appreciate in any way.
It is imperative to hold some amount of cash idle in a safe or checking account to pay for regular expenses and unforeseen expenses. However, the idea is not to hold too much cash as idle. Instead, one should use techniques like forecasting and budgeting to keep idle funds at a minimum.
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What Constitutes Idle Cash?
Cash is usually the bills or coins that act as a legal tender. However, for idle cash, the cash includes cash and cash equivalents. So, the cash that one deposits in a bank account, which gives no interest, such as a current account is also idle money. Even money sitting idle in your brokerage account is idle cash as it is not invested and not earns anything.
More Dangerous During Inflation
Holding idle cash become all more dangerous at a time of inflation. Because the longer you hold idle funds, the less they are worth.
Let’s understand this with the help of an example. Suppose you have $100 in your safe. Presently, you can buy 50 pencils for $100, but a year later, 50 pencils will cost you $105 because of the rise in the cost of raw materials. Thus, you lost $5 in purchasing power.
Now assume that you deposit this $100 in a bank account that gives you a 5% interest per year. In a year, you will earn $5 from this investment. In case, you didn’t make this investment, and the $100 is still in your safe, you will earn zero interest. Additionally, from the perspective of opportunity cost, you will be at a loss of $5.
So, the total loss will be $10 ($5 opportunity loss + $5 from due to inflation).
How to use Idle Money?
One can use idle money by either investing in an interest-bearing instrument, in the stock market, in a productive asset and more. An investor must select the option on the basis of their need, risk appetite, and financial goals. Following are the options where one can park their idle money:
If a business has idle cash, they can utilize it to buy new machinery, new plants or any other fixed asset that will help them to boost the production capacity.
If a business does not want to tie the funds into a long-term investment, then they can utilize it for purchasing inventory, prepay some expenses such as rent or insurance, or any other expenses crucial for the day-to-day operations of a business.
Putting it in Bank
One can also use the idle cash by depositing it in a bank account, either a checking or a saving account. A checking account is the most liquid and allows the user to withdraw cash immediately, but the interest is very less. However, earning something is always better than cash sitting idle and earnings nothing. A point to note is that not all checking account pays interest.
The owner can also deposit the cash in a saving account. Though it is not as liquid as the checking account, the interest rate is relatively higher.
Another option is to invest the money in a term deposit with a bank. It is similar to a bank account except that the funds get locked for some time. However, the interest on term deposit is relatively more than what one gets from the savings account. Similarly, there is a CD, or certificate of deposit.
Stocks and Bonds
One can also invest their idle cash in a debt or equity instrument. Investing in stocks is highly liquid as one can easily sell a stock in the secondary market. But the risk is higher and so are the expected returns. Bonds, on the other hand, are less liquid and are safer than stocks. But, the return is also relatively less than what one could earn from investing in the stocks.
Use it to Save Costs
Such spending of idle cash leads to long-term cost savings. For instance, a business can use the money to pay debt resulting in lower interest expenses or improve credit. A business can also create a sinking fund, which will act as a reserve to pay debts at regular intervals. In this case, a business can deposit the idle funds regularly in the sinking fund.
Boost Goodwill and Stock Price
Moreover, a business can also use idle many to redeem outstanding shares or pay a dividend or even buy back shares. Such a move could help in boosting share prices. Additionally, a business can also use the cash on employees to increase retention, such as investing in group health care, giving bonuses, stock options and more.
It is essential for every business (and even individual) to hold some idle cash. Such cash is highly liquid and allows a business to pounce on any opportunity that comes their way. However, a business must not hold too much idle cash as it will result in an opportunity loss and purchasing power loss as well.
A business must use budgeting and other available ways to determine the optimum level of cash they may hold and the rest they must invest to earn income from it.Last updated on : April 13th, 2019