Lesson 1 of 8
The five uses of cash
A company can reinvest, acquire, pay a dividend, buy back stock or repay debt. Sorting ten years of cash into the five shows what management actually chose.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- Cash a company generates has five uses: reinvest, acquire, pay a dividend, buy back stock, or repay debt.
- The choice is management's, and a decade of it is a readable record of judgment, not just of results.
- The same dollar retained by two managements can compound or can sit idle, so the split matters less than the return on the part kept.
Cash a business does not need for the year's operations can go five ways, or simply stay in the bank. Reinvestment and acquisitions grow the business. Dividends and buybacks return cash to owners. Debt repayment reduces a claim that ranks ahead of them. Ten years of that split is a record of what management chose to do with what it was given.
Ten years of cash, one company
Largest use
- Reinvested in the business$400m40%
- Acquisitions$250m25%
- Dividends paid$150m15%
- Shares bought back$150m15%
- Debt repaid · smallest use$50m5.0%
Smallest use
Total$1,000m
Holding cash is the sixth choice; Berkshire held $112 billion in U.S. Treasury bills and other cash equivalents at the end of 2018.
The choice is not neutral
None of the five is automatically right. Reinvestment only compounds if the business earns more on the new capital than it costs to raise. An acquisition only pays for the price if the target earns enough on what was paid for it, goodwill included. A dividend and a buyback both hand cash to owners, but a buyback also changes who owns the remaining company. Debt repayment earns the interest saved and lowers the risk ahead of the owners.
Two managements, one number
Why the record is worth reading in order
A single year rarely shows a pattern: a large acquisition or an unusual buyback can dominate one year's cash and mean little about the next. Reading ten years in sequence shows whether a management has a standing preference, whether that preference changed after a bad acquisition, and whether the preference shifted when the stock price moved. A management that bought back stock heavily when the price was high and stopped when it fell is telling you something a single year's total cannot.
Where the five uses are filed
| Use | Cash flow statement line | Section |
|---|---|---|
| Reinvestment | Capital expenditure | Investing |
| Acquisitions | Acquisitions, net of cash acquired | Investing |
| Dividends | Dividends paid | Financing |
| Buybacks | Repurchases of common stock | Financing |
| Debt repayment | Repayment of debt, net of new issuance | Financing |
Research spending and working capital are reinvestment too, but both sit in operating cash flow, not on the capital expenditure line above. An acquisition paid in shares, and pay in stock, never pass through the cash flow statement at all; the share count shows them instead.
Check yourself
Which of the five uses of cash has no upside beyond the interest saved?
- Repaying debt
- An acquisition
- Reinvestment
Show the answer
Answer: A.
Reinvestment and an acquisition can compound if the return earned beats the cost of the capital. Repaying debt only removes a fixed claim; it does not compound.Two companies each retain $1,000. Company A earns 18 percent on it and Company B earns 6 percent. What does the amount retained tell you about which management did better?
- Company B did better, because it kept more cash
- Nothing: both retained $1,000, and only the return earned on it separates them
- Company A did better, because it retained more
Show the answer
Answer: B.
The amount retained is identical. The 18 percent against 6 percent is what separates them, and no single line in the statements reports it.Why is a single year's split of cash a weaker signal than ten years of it?
- Because only ten-year totals are audited
- Because a single year is never disclosed
- Because one large acquisition or buyback can dominate a single year without describing management's standing preference
Show the answer
Answer: C.
One year can be swamped by a single unusual item. A standing preference, and how it shifts with the share price, only shows up across a run of years.Sources
- Thorndike, The Outsiders, 2012, quoted in Faber, Shareholder Yield, 2013, on the five uses of capital and the three ways to raise it.
- Berkshire Hathaway shareholder letter, 2018, on Berkshire's Treasury bill and cash equivalent holdings at yearend.
What this leaves out
- The stack and the two-company example use round invented numbers so the arithmetic can be checked by hand.
- This lesson sorts cash into categories. It does not say which split is best for any company, and the right split differs by industry and by opportunity.
- Nothing here is advice about any security.