Cash-Cow companies

What is the single most important need for any business? There will be many answers to this question, however, they all boil down to the need for cash. A steady stream of finance in the business is the key to solving all the problems and ensuring that there is never a liquidity crunch. Therefore, if a business has such a source of meeting their financial needs in-house, they will not need to look for external sources and be heavily debt-strapped. Such cash-rich companies can milk the revenues virtually forever and therefore, are also known as cash-cow companies. 

Given below are details related to the cash cow companies and their important characteristics.

What is the meaning of a cash-cow company and why are they important?

Many businesses have cyclical products or products that move through different stages of the life cycle right from their introduction in the market to stagnation and eventual decline. However, there are also some products that are evergreen, i.e., the demand for them never ceases. 

The companies having these products have already put in the hardwork and have managed to create a profit making product through years of research and development as well as understanding the market dynamics. The resultant product is a market leader and has created success stories over and over again. Such companies need not put in too many efforts to drastically change their products or find new variations to attract consumers. 

They simply need to fine tune their products or strategies to fit the current market conditions. These products become a money making machine for the company and are, therefore, also referred to as cash-cow products and the companies being cash-cow companies. This term is usually used in the BCG matrix and coined by them to classify companies and their business models. 

As mentioned, cash-cow companies have products that usually enjoy an undisputed maximum market share. The income from such products is usually twice its overall expenses and can help fund other operations of the business. This eliminates the need for excessive external finance and helps in reducing the cash outflow from the business in the form of huge interest payments and ultimately reducing the overall cost of capital. 

What are the characteristics of cash-cow companies?

Investing in a cash-cow company can be beneficial for the investors as well. For this, they need to understand the key characteristics of such companies that can help in identifying them. Some of the key characteristics of a cash-cow company and the ways to identify it are highlighted below.

1. Such companies primarily have a successful product or a business model that does not need high maintenance, excessive cash inflows, or constant research and development.
2. Cash-cow companies or products enjoy high market share but low or negligible market growth rate.
3. These companies enjoy a loyal customer base for their product or products and have the benefit of economies of scale as well as lower manufacturing costs that ultimately translate into higher revenue for the company.
4. Another key characteristic of such companies lies in their fundamentals. The current ratio of such companies is usually 2 or more which implies that its current assets are more than twice to accommodate the short term liabilities.
5. Quick ratio of such companies is sufficiently high, usually 1 or more, to indicate a comfortable liquidity position and ensure that there is no cash crunch to meet its growth or mandatory financial obligations.
6. The capital appreciation of the stock may be lower but investors can expect a more or less steady source of income through dividends.

What are the advantages of cash-cow companies?

Some of the ke advantages of cash-cow companies are mentioned below.

1. Investment in cash-cow companies can benefit te investors as they are considered to be low risk investments. Such investments are ideal for risk averse investors as they can gain more or less stable or steady returns and avoid extreme market volatility.
2. The businesses can benefit from a steady source of funds that can be used in other projects or divisions that may need expansion, higher innovation or face higher competition. Revenues from cash-cow streams of the business can also be used as reserves for a rainy day or in times or recession to stabilize the organization.
3. Cash-cow companies or products enjoy market dominance and are therefore price makers as well. They set a benchmark for the industry or the product in terms of quality or accessibility.

What are the disadvantages of cash-cow companies?

Limitations are part of every market or industry and some of the key limitations of cash-cow companies or products are mentioned below. 

1. These companies or products enjoy larger market share often to the point of monopoly. This dominance discourages new players from entering the markets and can ruin small players by completely eliminating them from the industry.
2. Such companies need to constantly maintain their product quality and services offered to enjoy the continual customer trust. Any deviation can lead to loss of customer faith and they will end up losing their market dominance.
3. These companies cannot enjoy or expect any drastic increase in market share or profits as they are already at the mature levels and they simply need to be maintained.
4. Creating the same amount of confidence and market presence for another product in the same industry can be difficult.

Conclusion

It is ideal for a company to have atleast one cash-cow product that can generate a steady source fo revenue to meet all its obligations and also fund research and development in other areas of the business. Such companies or products do not need continual excessive capital investment and can therefore be beneficial to the business and the investors alike for almost perpetuity. 

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