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Are CFO's hoarding cash again?

It seems in the CFO literature that we CFO's are hoarding cash again. Are we? And if we are (more than usual that is), why? Rainy day fund? Armageddon? The great depression?

Answers

Topic Expert
Mary Driscoll
Title: Senior Research Fellow
Company: APQC (American Productivity and Quality ..
(Senior Research Fellow, APQC (American Productivity and Quality Center)) |

Hi Wayne,
You are very current! I am currently editing a research paper we will publish soon that shows that YES indeed, despite very low money market rates and ample cash cushions, organizations that can get away with it are squeezing suppliers, extending payments and hoarding cash. Why? Because they can. The practice of tightening the belt on working capital mgt. has gone on auto pilot and CFOs are looking to make their balance sheets appear as strong as possible to prove to investors they are going after every last dime on the table--with no regard to the negative consequences imposed on small and mid-sized business that do not have easy access to affordable credit revolvers.
I'd love to hear your take on this.
Mary Driscoll
mdriscollatapqc [dot] org

Topic Expert
Wayne Spivak
Title: President & CFO
Company: SBAConsulting.com
LinkedIn Profile
(President & CFO, SBAConsulting.com) |

Thanks Mary, I attempt to be.... not always succeeding...to be current.

Small and midsize businesses are having difficulty with primary lenders (banks) because they want no risk portfolios.

By definition small and the smaller mid-size companies are risky (not to say large business isn't). The secondary lenders are by in large expensive to predatory.

What the large businesses fail to understand is that most of the clients (or end-users which is probably a more correct term) are small businesses. Squeeze them and what happens to consumption?

Chris Shumate
Title: Accounting Manager
Company: Dominion Development Group, LLC
LinkedIn Profile
(Accounting Manager, Dominion Development Group, LLC) |

From the standpoint of our business, we are hoarding cash out of necessity. We are a growing general contractor with ample amounts of work going on and coming in. In order to ensure we are able to get bonding for upcoming projects we need to have cash on hand and cash available via a line of credit (among other balance sheet items which are attributed to current ratio and such).

To Mary's point too, we have been able to negotiate new payment terms to suppliers and subcontractors, which is helping our balance sheet look favorable because of the tightening we are doing.

Another tactic we have been able to implement well recently is rebate programs with suppliers. Rebates are basically free money in that it is cash we are receiving back from business we have given to the suppliers.

So for us, it's out of business necessity that we are "hoarding" cash. But it is keeping our banker and bonding company happy.

Serge Wind
Title: Instructor, Department of Finance
Company: NYU School of Professional Studies
(Instructor, Department of Finance, NYU School of Professional Studies) |

U.S. companies outside of the finance industry are holding record-high amounts of cash on their balance sheets – $1.73 trillion at the end of 2014. Cash holdings have tripled since 2000, although the corporate cash rate – corporate cash holdings expressed as a share of net assets – has been increasing since 1980. The post-2000 surge in the corporate cash rate indicates cash is growing faster than the companies’ net assets.

The post-2000 increase in corporate cash is largely attributable to record after-tax corporate profits, expressed as a share of GDP, coupled with corporations neither redistributing the larger share of business national income to investors (via share repurchases) nor investing it in new fixed assets (plants and equipment), newly-hired employees, updated technology, or acquisitions (until the last 9 months). Profitability has been enhanced by a shift in corporate income from employee compensation to capital; globalization and technological advances which began in 2000 to replace employees with labor-saving software and automation or lower-paid and lower-skilled workers overseas; and stagnating wages, with nominal hourly wages growing at about the same low annual rate since 2010.

Despite record profits, companies are not reinvesting in their own business. Some companies are delaying their investments and acquisitions until aggregate demand in the form of consumer spending increases, and uncertainty about increasing exposure to rising pension and healthcare costs associated with aging workforces and other tax and regulatory policies abates.

Additional factors have led to higher cash holdings. Increasing profits of U.S. multinationals from overseas operations would be heavily taxed if repatriated; these profits currently represent over 60 percent of total corporate cash. Reflecting the post-1980 shift in corporate income from employee compensation to capital, the income not paid to labor was in large part retained as profits saved in the corporate sector and not returned to shareholders as dividends. In addition, the post-1980 corporate investment rate declined, attributable in part to slowing GDP growth.

Reacting to the financial market illiquidity they encountered during the banking and credit crisis of 2008-09, many companies now hold larger cash balances due to their growing sensitivity to the economic cycle and continued need for operational funding, even when credit markets freeze.

Stockpiling cash can help companies maintain stronger credit ratings and ensure near-term debt can be paid off if there are swings or disruptions in the capital markets. However, it has been suggested – in the absence of value-added investments – shareholder value may not be maximized unless excess cash is used for distribution via share buyback and/or increased dividends. Excessive non-earning cash balances decrease the rate of return on equity – and hence the stock price – and reduce free cash flows and the firm’s value.

The declining employee compensation share of corporate income and the resultant increase in the corporate cash rate have also contributed to widening income inequality and slowing the recovery of jobs lost during the past recession, as delineated in a paper accessible at SSRN: http://ssrn.com/abstract=2441795.

Serge L. Wind
swind2atnyc [dot] rr [dot] com

Bruce Lynn
Title: Managing Partner
Company: The FECG LLC
(Managing Partner, The FECG LLC) |

Asking a question like "Is a CFO hoarding cash" is like asking "how much liquidity is enough?". There is no right answer to the question.

Also, it begs another question, "If a CFO is hoarding cash, What is he/she hoarding it for?". Often this question goes unanswered although lately (e.g. General Motors) some investors have been actively pushing management to come up with answers.

As has been pointed out there is more cash today on company balance sheets than ever, even when compared to periods before the "Great Recession"; however, these cash balances and comparisons to prior periods ignore the make up of this cash "hoard" and do not speak to the "enough" question.

All CFOs and their treasurers should be concerned with optimizing sources of funds with uses. Based on the latest figures it would appear that cash as a percentage of assets is increasing, but that metric doesn't tell the whole story:

- At technology companies (e.g. Apple) that cash is "frozen" offshore and cannot be used without triggering a large tax cost that some companies wish to avoid. In Apple's case they borrowed more ans incurred additional costs despite having billions of dollars of cash on the balance sheet.

- While debt maturities at some companies has been pushed out, the amount of debt on the balance sheet continues to increase. Since this debt remains on the balance sheet so to does the need to service future repayments, a use of cash.

- Investors have been actively asking for some of this cash back in the form of stock buybacks / dividends. With operating cash flow still volatile (uneven demand?) many CFOs maybe hedging their bets and wish to retain "enough" cash balances for CAPEX or acquisitions in order to gain a jump on their competitors when the time is right, whenever that is..

- New regulatory demands on banks has made both sides wary of lending / borrowing "too much". In a rising rate environment both sides could find the cost of a "mistake" to be costly. From a corporate perspective it may be better to retain more "dry powder" than before. To some this could be considered hoarding.

Bottom line: hoarding is in the eye of the beholder, but in a rising interest rate environment under utilization of an asset / cash flow or over borrowing for any reason runs the risk that either investors or competitors will punish a company's stock price and / or the CFO for under performance if that "hoarded" cash is not put to a best use.

Maybe the better question to ask is not about hoarding but whether a company is over borrowed, under invested or over exposed.

Serge Wind
Title: Instructor, Department of Finance
Company: NYU School of Professional Studies
(Instructor, Department of Finance, NYU School of Professional Studies) |

CFOs and treasurers of companies currently holding relatively high levels of cash are becoming aware that they will now be facing a markedly different cash investment environment affected by several major pending changes.

Companies currently are unwilling to repatriate cash held overseas representing foreign-based earnings – $2.10 trillion in profits were held overseas by U.S. companies as of the end of 2014 – which would be subject to an added 35 percent U.S. tax rate. These multinational U.S. companies would consider bringing a portion of that cash to the U.S. if current bipartisan Congressional tax discussions on revamping the tax structure result in a significantly lower corporate tax rate on foreign profits. However, political gridlock in Washington, coupled with the opposition of vested interests to broad changes in the tax code, may impede any tax changes.

With the dollar strengthening versus most major trading currencies – beginning in late 2014, continuing through 2015 and possibly in 2016 – the value of offshore earnings is decreasing in those jurisdictions.

Short-term interest rates are likely to slowly begin rising when the Federal Reserve Bank raises the federal funds rate, probably either in September or December of 2015. Rising rates may prompt activist shareholders to strongly suggest that the huge coffers of low-earning, or non-earning, cash not needed for investment in capital and R&D spending will generate increased value if they were instead distributed via share buybacks. Cash held overseas representing foreign-based profits, particularly by technology and pharmaceutical companies, might similarly be considered for future acquisitions outside the U.S., foreign subsidiaries’ share of developing intellectual property and capital expenditures, possibly leading to increases in foreign-based jobs.

In addition, two of the favorite repositories of corporate cash – bank deposits and money market funds – are undergoing major changes due to regulatory reforms.

With new Basel III regulations forcing banks to hold greater reserves against demand deposits, many banks are no longer welcoming cash deposits from their corporate customers. With lower interest rates than in the U.S., some European banks are now imposing negative interest rates on excess cash in corporate deposit accounts. Separately, in July the Federal Reserve introduced new, higher capital requirements that would apply solely to the eight largest U.S. banks, which hold more than $10 trillion in loans and securities.

New SEC regulations, due to take effect in the summer of 2016, will force institutional prime money market funds to have floating net asset values (NAV). Imposition of 2 percent liquidity redemption fees and withdrawal gates – suspension of redemptions for 10 days – would also be applicable if the weekly liquidity of a fund falls below 30 percent of its portfolio value. The change to a floating NAV means investors in prime funds could lose money, likely diminishing the attractiveness of companies investing their cash in money mutual funds formerly considered very safe and liquid.

Moreover, smaller-sized and newly-formed corporations may need to re-examine the credit ratings of their banks, which may have deteriorated since the banking crisis of 2008-09.

Finally, if the economy continues to improve, companies will likely have to add plant and equipment via higher capital expenditures to meet increased consumer demand emanating in part from more Americans working, with their nominal hourly wages eventually growing in excess of the post-2010 low annual rate of 2 percent. Then cash invested in capital and R&D spending will add to shareholder value, leading to a virtuous circle of strong investment fueling aggregate demand, job creation and growth in GDP. However, corporate investment in capital and R&D spending has remained below expectations in non-recessionary years since 2001, marking this potential use of cash as probably the most uncertain, along with changes in corporate tax rates.

The markedly different cash investment environment may serve as a catalyst for CFOs and corporate treasurers to begin managing cash more actively. Some senior finance professionals are adopting conservative and prudent measures to guide investments of excess cash in unfamiliar short-term investment products and, possibly, non-traditional global asset classes, like real estate and REITS (real estate investment trusts), master limited partnerships (MLPs) and alternatives. Companies are also considering modifying and updating their corporate cash investment guidelines to be responsive to the changing composition of suitable short-term cash investment vehicles and the potential need to consider modest yield (relative to risk) as well as capital preservation and liquidity.

Serge L. Wind
swind2atnyc [dot] rr [dot] com

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