Recently Boeing has maintained a cash balance of over $6 billion. At an annual inflation rate of about 2 percent, does cash have more or less purchasing power at the end of a given year than at the beginning? By how much? Is such a gain or loss reflected on the company’s financial statements? Why or why not? Why would Boeing want to keep its cash balance as low as possible? Why doesn’t the company reduce its cash balance to zero?

Question

Recently Boeing has maintained a cash balance of over $6 billion. At an annual inflation rate of about 2 percent, does cash have more or less purchasing power at the end of a given year than at the beginning? By how much? Is such a gain or loss reflected on the company’s financial statements? Why or why not? Why would Boeing want to keep its cash balance as low as possible? Why doesn’t the company reduce its cash balance to zero?

Answer 1

To determine whether cash has more or less purchasing power at the end of a year, we need to consider the effect of inflation. Inflation erodes the value of money over time, meaning that the same amount of cash will be able to buy fewer goods and services in the future.

To calculate the change in purchasing power, we can use the formula:

Change in Purchasing Power = Cash Balance * Inflation Rate

Using the given information, we can calculate the change in purchasing power:

Change in Purchasing Power = $6 billion * 2% = $120 million

Therefore, at the end of the year, the cash balance of Boeing will have $120 million less purchasing power due to inflation.

However, it's important to note that this change in purchasing power is not reflected on the company's financial statements. Financial statements are prepared using historical cost accounting principles, which do not take into account changes in the value of money due to inflation.

Boeing may want to keep its cash balance as low as possible to minimize the opportunity cost of holding idle cash. Idle cash does not generate returns or contribute to the company's profitability. By keeping a lower cash balance, Boeing can deploy the excess funds into more productive investments, such as research and development, acquisitions, or capital expenditures.

Boeing doesn't reduce its cash balance to zero because having some cash on hand is essential for day-to-day operations and financial stability. Cash is required to cover short-term expenses, such as payroll, rent, and supplier payments. Additionally, it acts as a cushion during unexpected events or economic downturns, enabling the company to navigate through challenging times without being overly reliant on external financing or risking solvency.

Overall, maintaining an optimal cash balance requires a delicate balance between the need for liquidity and the opportunity cost of holding idle cash.