Days cash on hand definition
/What is Days Cash on Hand?
Days cash on hand is the number of days that an organization can continue to pay its operating expenses, given the amount of cash available. Managers should be aware of the days cash on hand when a business is starting up, and is not yet generating any cash from sales. It is also worth reviewing during the low part of a seasonal sales cycle, when there may be no sales. You should also examine days cash on hand during a transition to a new product line, when sales of the old product line are poor and declining.
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How to Calculate Days Cash on Hand
A key assumption in determining days cash on hand is that there is no cash flow from sales; instead, there are just operating expenses, such as salaries, rent, and utilities. To determine the amount of these operating expenses, use the operating expenses subtotal in the income statement, and subtract all non-cash expenses (usually depreciation and amortization). Then divide by 365 to determine the amount of cash outflow per day. Finally, divide the cash outflow per day into the total amount of cash on hand. The formula is:
Cash on hand ÷ ((Operating expenses - Noncash expenses) ÷ 365) = Days cash on hand
Example of Days Cash on Hand
A startup company has $200,000 of cash on hand. Its annual operating expenses are $800,000, and there is $40,000 of depreciation. Its days cash on hand calculation is:
$200,000 ÷ (($800,000 Operating expenses - $40,000 Depreciation) ÷ 365 days)
= 96 Days cash on hand
Problems with Days Cash on Hand
There are several issues associated with the days cash on hand measurement, which are as follows:
Basis of the calculation. Days cash on hand is based on an average daily cash outflow, which is not really the case. Instead, cash tends to be spent in a lumpy manner, such as when rent or payroll are paid.
Not representative of reality. Management tends to take drastic action to reduce expenses as cash reserves decline, so that the actual days of operation tend to be longer than indicated by this ratio. Thus, it is better to use a detailed cash flow analysis to determine the precise duration of the available cash, with regular updates.