Businesses, whether large enterprises or small retail organizations, are always vulnerable to contingencies, such as economic downturns, sudden financial crises, and market fluctuations. These challenges pose a constant threat to working capital erosion and lower liquidity even for businesses with substantial revenues or reserves. To ensure they can cover expenses and sustain daily operations, businesses must understand how much cash they would require to remain afloat without relying on additional revenue.
This is where days cash on hand (DCOH) comes into play. It is a financial metric that helps determine the number of days your existing cash flow can meet your operational expenses. It not only helps evaluate the liquidity and economic stability of a business but also enables accurate financial forecasting and planning.
This blog will guide you through the concept of days cash on hand, its elements, how to calculate it, and its benefits and limitations.
Days cash on hand is a financial metric that measures the number of days a business can continue to fund its operating expenses using its available cash. DCOH is used to assess a firm’s liquidity and financial health while highlighting likely cash flow issues.
One of the primary assumptions with DCOH is that the business has no current cash inflows from sales. The metric will help determine how many days the business can operate if there is no sales revenue. If DCOH is low, businesses may find it difficult to meet short-term obligations, such as rent, salaries, and vendor payments.
Additionally, analysts should be aware of the day’s cash on hand, especially when a business is in its early phase and not generating cash from sales. Similarly, if a business is undergoing low seasonal sales, it may not be able to generate optimal revenues and would need to determine DCOH to prevent financial downturns. This metric is also immensely useful for situations where a business is transitioning into a new product line, especially when revenue from old products is declining.
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Calculate the days cash on hand by dividing cash on hand by average daily operating expenses. Cash on hand includes liquid assets owned by the business. Average daily operating expenses is derived by subtracting non-cash items from the total operating expenses, then dividing by 365.
Note that different industries have different working capital requirements, so the ideal DCOH ratio may vary from one sector to another. Businesses should compare DCOH with companies belonging to the same industry to ensure accurate benchmarking and ensure efficient cash flow management.
Days cash on hand involves two components—daily operating expenses and cash on hand. Cash on hand refers to a business’s existing or current cash reserves. For average daily expenses, one needs to subtract non-cash expenses from annual operating expenses.
Operating expenses refer to a business’s daily costs incurred to ensure smooth operations. These expenses include salaries, rent, utilities, marketing, and other expenses needed to manage the company operations. Accurately recording all operating expenses is critical as it highlights a business’s ability to meet these costs with the available cash on hand.
However, while calculating days cash on hand, non-cash items like depreciation or amortization expense should be subtracted from total operating expenses, as these expenses don’t impact a business’s overall cash flow.
It refers to all the liquid assets being held by a business over a period of time. Cash includes deposits and physical currencies held in banks, including short-term investments, that are readily convertible to cash with a maturity period of three months or less.
On the other hand, cash equivalents include treasury bills, commercial papers, or money market funds. Using this element in the DCOH formula enables businesses to find out their financial health and the ability to meet operating expenses over a given period with the available cash.
Here are the steps to calculate the DCOH ratio.
Suppose an IT startup currently has $100,000 in cash and cash equivalents. The company needs to evaluate how long it can sustain its operations without cash inflows due to unforeseen circumstances.
Inputs for Calculation:
Cash on Hand: $150,000
Annual Operating Expense: $600,000
Depreciation and Amortization (D&A): $30,000
Step 1: Calculate Annual Cash Operating Expense
Annual operating expense – non cash expense (D&A)
= $600,000 – $30,000
= $570,000
Step 2: Calculate Daily Cash Operating Expense
Annual cash operating expense/365
= $570,000/365
= $1,561.64 (approx)
Step 3: Calculate Days Cash on Hand
Cash on hand/Daily cash operating expense
= $150,000/$1,561.64
= 96 Days
The startup, therefore, has approximately 96 days of cash on hand before it needs to secure additional financing or implement measures to generate revenue.
A higher DCOH value means a company has conservative financial management. However, it might also highlight inefficient cash utilization, indicating that the business is unable to make an effective use of its cash reserves. This could also be due to inefficient investment strategies, lack of growth initiatives, or over-reliance on cash. On the other hand, a lower DCOH may indicate potential liquidity concerns, highlighting that the business needs to focus on cash management practices.
The industry standard also plays a vital role in DCOH interpretation. For instance, industries with long collection cycles or high capital expenditures would maintain a higher DCOH. Contrarily, companies with a quicker cash sales and inventory turnover ratio, like retail, may operate using lower cash reserves without hurdles. Therefore, businesses must benchmark against industry peers to get a more meaningful analysis of their liquidity.
Additionally, seasonal variations can also impact this financial metric. For businesses that accumulate cash in expectation of slow sales or upcoming large expenses, a point-in-time measurement may not help fully capture the nuances of a business’s cash flow cycle. Analyzing the trend over multiple time periods will offer a more accurate assessment of liquidity management and operational efficiency.
Days cash on hand is critical for determining the short-term financial stability and readiness of a business to handle unexpected disruptions. It is a vital metric for financial evaluations across industries and helps businesses make informed decisions regarding business budget preparation and financial planning.
DCOH helps managers and investors compute a business’s short-term financial health by evaluating available cash to meet operating expenses.
Businesses can compare DCOH ratios with their competitors or industry standards to determine their performance and financial stability.
A higher DCOH ratio means a business has lower risk since it has more cash in its reserves to settle its short-term financial obligations, thereby preventing cash flow issues.
Despite being a critical metric, especially for businesses in its early stages, DCOH comes with several challenges.
DCOH relies on historical data and does not account for future cash flows. As a result, the ratio may not accurately reflect a business’s future liquidity position.
Businesses of a seasonal nature may see varying DCOH ratios throughout the year, making it difficult to gain accurate conclusions from single data points.
The formula for the day’s cash-on-hand ratio is based on daily cash outflows, but that is not always the case for most of the businesses. Businesses usually spend cash in a lump sum, which means on some days businesses will have no cash outflow, and on other days, there might be significant expenditure to be incurred.
The DCOH ratio gives a partial picture of a business’s financial soundness, as it only considers liquidity and ignores factors, such as leverage and profitability. It should be used in conjunction with other critical financial ratios for a better comprehensive analysis.
One of the best ways to improve DCOH is to have automated cash forecasting software and cash management software in place that will not only help you get real-time visibility into cash positions but also improve scenario planning and accurate forecasting.
Automated cash forecasting software leverages ML-powered category forecasts that use auto-machine learning systems trained on historical transaction data to create cash forecasts. It selects the best fit and relevant model from hundreds of combinations by category and time frame.
An automated cash forecasting solution offers scenario analysis software that helps create and tweak what-if scenarios over base forecasts and compare multiple scenarios with one another. For example, a company is planning to build a $100 million factory. They will have to borrow $50 million and use $50 million of their cash to do this. They want to know the effect on overall cash if they start the project next month (Scenario 1) or if the project is delayed 45 days due to bank approvals (Scenario 2).
An automated cash management software offers daily cash positioning that analyzes bank balances using dynamic dashboards and creates unlimited cash position templates to analyze global cash positions by company, bank, country, etc. It creates or uploads bulk cash transactions, eg-AP, AR, payroll, tax, etc.
With solutions like bank connectivity manager, businesses can leverage out-of-the-box integration with all major banks to provide rapid access to bank statements. It parses standard banking formats (BAI2 & MT940) and then categorizes cash into inflows and outflows. For example, a company has 24 total accounts spread across BofA, Citi, HSBC, and JP Morgan, with ~12,000 daily transactions. These transactions are automatically pulled into cash management daily, categorized, and mapped to the region and entity.
Features like this help manage general ledger posting rules for bank transactions. Automatically generate general ledger entries for bank transactions to ERP. For example, a monthly bank Fee of $5,000 is charged in the bank account, and someone in accounting will have to manually create the journal entries for that expense. The system automatically creates the GL entries based on user-defined accounting rules.
HighRadius offers a cloud-based Treasury Management System that streamlines and automates treasury operations, including cash forecasting, cash management, and treasury payments. We have empowered the world’s leading companies, like Danone, HNTB, Harris, and Konica Minolta, to optimize their cash forecasting accuracy, make decisions faster with real-time bank data, and reduce bank fees.
Our Cash Forecasting Software leverages advanced technologies such as artificial intelligence (AI) and machine learning (ML) and integrates with banks and ERPs to get AR/AP data, improve ML prediction rates, and enable treasurers to achieve accurate, real-time cash forecasting. Businesses can forecast cash into any category or entity on a daily, weekly, and monthly basis with up to 95% accuracy, perform what-if scenarios, and compare actuals vs. forecasted cash.
Our Cash Management Software automates the reconciliation process between bank statements and internal financial records, reducing manual effort and errors and increasing cash management productivity by 70%. With our treasury and risk solutions, treasury professionals gain instant, personalized insight into their cash positions with unparalleled global visibility.
Days cash on hand depends on industry, company size, and other business factors. Usually, a ratio of 30-90 days is considered as good as it shows that there is sufficient liquidity with the businesses to settle operational costs for a given amount of time. For other industries, it can be as little as three months.
Hospitals generally have a higher days cash hand ratio. This is mainly due to their higher operational costs and fluctuating income sources. For hospitals, a days cash on hand ratio is recommended to be anywhere between 157 – 273 days. However, startups might need more cash reserves compared to established businesses.
A typical ratio for days cash on hand recommended for a nonprofit organization is between 90 and 180 days. This roughly translates to 3-6 months of operating expenses, depending on the organization’s financial soundness and risk profile. Most experts suggest a range of 3-6 months of reserves.
Hospitals should aim for around 200-275 days of cash on hand. Strong levels though are considered to be between 160-205 days for standalone hospitals and 150-200 days for hospital systems. However, the number varies depending on the hospital size, location, and financial health.
It is usually better to have a higher days cash on hand ratio as it shows more cash reserve and that a business is financially stable and flexible to deal with unexpected expenses or settle additional debts. However, a very high ratio also means that a business has an inefficient capital allocation.
To calculate “days on hand” in Excel, use the formula: (Average Inventory / Cost of Goods Sold) * Number of Days in the Period. This involves dividing your average inventory by the cost of goods sold, then multiplying the result by the number of days in the period you’re examining (typically 365 for a year).
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