corporate cash

If the effort to cut the maximum U.S. federal corporate tax rate to 20% from 35% succeeds, will corporations reverse their current trend and allocate more funds to capital expenditures?

That question arises from the findings of the Georgia Tech Financial Analysis Lab’s report on cash-flow trends in 2017’s second quarter. “Tax reform holds the potential to unlock cash and short-term investment balances and drive a renewal in capital expenditure spending,” the report’s authors write.

But sustained corporate revenue and cash flow hasn’t been “translating into a much-anticipated increase in capital expenditure investments, which would likely enhance economic growth,” they say.

To be sure, median revenues increased to a record level of $1.5 billion as of June 2017, up 13% year-over-year from $1 billion in June 2016, according to the study of 2,610 non-financial public companies with total assets of $100 million or more.

In addition to strong sales, the researchers found cash-flow numbers that were “suggestive of positive economic conditions,” with median cash and short-term investments growing to a record $147 million, up 8% from the $136 million reported in June 2016.

Despite the robust sales and cash figures, capex continued its longstanding tepidness, dipping from 3.93% of revenue in June 2016 to 3.74% in June 2017.

“This softness in capital expenditures continues to be a trend worth monitoring, as spending remains well-below the level of investment needed to replace capital expenditures lost during the recession,” according to the study.

The Georgia Tech report focuses on free cash flow and free cash margin. The authors define the former as “cash flow available for common shareholders that can be used for such discretionary purposes as stock buybacks and dividends without affecting the firm’s ability to grow and generate more.” The metric is calculated as operating cash flow minus preferred dividends and net capex. Free cash margin is free cash flow divided by revenue.

The June study reports that median free cash margin decreased to 4.90% for the twelve months ended June 2017. That compared with 5.28% for the twelve months ended March 2017 and 4.64% in June 2016. “This metric is down slightly from the last reporting period, but is still running well above pre-and post-recession norms,” the researchers say.

“Similar fluctuations in free cash margin have been seen in other periods with healthy economic growth, and this would appear to be no different,” they observe.

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One response to “Will Tax Cuts Boost Capital Spending?”

  1. The election to expense the costs of capital equipment is not quite as valuable as it seems. It’s simply a matter of timing .Without the expensing option, the equipment would be depreciated for tax purposes over prescribed periods (for most plant and equipment it would be 5 years), so the expensing option provides for earlier, not additional, tax write-off. Under current rules, five year equipment is depreciated using the declining tax basis method at accelerated rates, which somewhat reduces the apparent benefit of early expensing. Also, there is the assumption that the business actually has enough taxable income to cover the expensed amont, because it cannot reduce taxable income below zero (the excess is carried forward to the next year in which it can be absorbed). If a manufacturer elects to expense equipment with a cost basis of $200,000 in Year #1 and has at least $200,000 of taxable income before the write-off, depreciation of $200,000 which otherwise would have been spread over Years #1 through #6 (tax depreciation on “five year” equipment is spread over 6 years at prescribed rates for each year) is taken in Year #1, so no depreciation deduction would be taken in Years #2 through #6. Again, the real benefit of the expensing election is one of timing – the time value of the tax dollars saved in year #1 that are effectively paid back to the IRS over the remaining life of the equipment.

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