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?
To determine if cash has more or less purchasing power at the end of the year, we need to consider the effect of inflation. Inflation erodes the value of money over time, meaning the same amount of money can buy fewer goods and services.
To calculate the change in purchasing power, we can use the formula:
Change in Purchasing Power = Cash Balance * Inflation Rate
In this case, the change in purchasing power would be:
Change in Purchasing Power = $6 billion * 2% = $120 million
So, at the end of the year, the cash balance would have $120 million less purchasing power due to inflation.
However, it's worth noting that the actual impact on purchasing power might be different since cash might be invested or generate interest over time. But assuming we are only considering the cash itself and not any returns or investments, the above calculation represents the change in purchasing power due to inflation.
Regarding the second part of the question, changes in purchasing power are not reflected in a company's financial statements. Financial statements focus on reporting the company's assets, liabilities, equity, income, and expenses based on historical costs and generally accepted accounting principles. They don't consider changes in the value of money due to inflation as it's not directly related to the transactions and events recorded in the financial statements.
Now, let's address why Boeing would want to keep its cash balance as low as possible, but not reduce it to zero. Maintaining a certain level of cash balance is essential for the company's liquidity and financial stability. It allows Boeing to meet its short-term obligations, such as paying suppliers, employees, or covering unexpected expenses. A sufficient cash balance ensures that the company can operate smoothly and withstand any financial challenges or uncertainties.
On the other hand, keeping excessive amounts of cash is generally considered inefficient since it isn't earning any significant returns. This is why Boeing might want to keep its cash balance as low as possible, to maximize the utilization of its funds and invest in more profitable ventures.
However, reducing the cash balance to zero is not advisable as it leaves the company vulnerable in case of emergencies or unforeseen events. Having no cash reserves means Boeing would have no immediate means to address urgent needs or unexpected situations. Therefore, maintaining a balanced cash position that provides enough liquidity while minimizing idle cash is a prudent financial management strategy.