Precautionary motive

Definition

The precautionary motive is the desire to hold cash or liquid assets as a safety net against unexpected financial needs. It ensures that a company can meet unforeseen expenses without disrupting regular operations.

5 Must Know Facts For Your Next Test

1. The precautionary motive helps businesses manage risks associated with unpredictable events.
2. Holding cash for precautionary reasons can reduce the need for emergency borrowing.
3. It differs from speculative and transactional motives, which are driven by profit opportunities and day-to-day expenses respectively.
4. Maintaining an optimal level of cash reserves is crucial to balance between liquidity and opportunity costs.
5. Precautionary balances are influenced by the overall economic environment and the specific risk profile of the business.

Review Questions

• Why is the precautionary motive important for businesses?
• How does holding cash for precautionary reasons differ from holding it for transactional purposes?
• What factors influence the amount of cash a company holds for precautionary motives?

Related terms

Trade Credit: An agreement where a buyer can purchase goods on account, paying the supplier at a later date.

Working Capital: The difference between current assets and current liabilities, indicating short-term financial health.

Cash Management: The process of collecting, managing, and investing cash in a business to ensure liquidity and profitability.