Growth Strategies

The Black Hole of Restricted Cash

FASB is working to provide specific guidance to corporations on how to report restricted cash.
David KatzSeptember 30, 2014

There’s no doubt that Apple, with nearly $38 billion of cash on its balance sheet, is the company that critics of corporate cash-hoarding love to hate.

Charles Mulford, director, Georgia Tech Financial Analysis Lab

Charles Mulford, director, Georgia Tech Financial Analysis Lab Financial statement

But the personal-computing goliath isn’t alone in its preference for hanging on to as much of the green stuff as possible. Since the recession, the growth in corporate cash holdings has been stratospheric.

According to data culled by the Georgia Tech Financial Analysis Lab, median cash and short-term investments for 3,000 large public companies had increased 28.9%, to $86 million in September 2013, from $66 million in June 2009.

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Summing up the criticisms of excessive cash retention, Charles Mulford, a Georgia Tech accounting professor who runs the lab, says that “cash is a non-productive asset.”  Instead of holding on to so much cash, corporations, it’s said, could be investing in such things as plants, equipment and hiring — thereby generating more growth in the sluggish economy.

Bad as those huge caches of cash look to many investors, the overabundance of non-productive holdings in corporate financials may be worse than they think, according to Mulford. Over and above the liquid assets currently contained on balance sheets, he says, are large amounts of scantily reported restricted cash – cash that’s already spoken for to pay for bankruptcy reorganizations, equity transactions, income tax, insurance claims and the like.

Such allotments tend to be excluded from the cash balances most analysts refer to, which they define as cash and cash equivalents (CCE) plus short-term, highly liquid investments. Under Securities and Exchange Commission rules, restricted cash must be reported separately from cash and cash equivalents on the balance sheet and its purpose described in the footnotes to the financial statements.

To be sure, restricted cash doesn’t amount to a material amount on most financial statements. For instance, a new study by the Georgia Tech financial lab of 41 nonfinancial companies with market caps exceeding $10 billion found that restricted cash comprises only about 0.80% of total assets, although for some companies it can amount to several percentage points of total assets.

That said, restricted cash can amount to a considerable chunk of change, “and for some companies, it’s material,” says Mulford. The median amount of restricted cash for the Georgia Tech sample is $102 million.  Chevron’s $1.5 billion was the highest amount of restricted cash for the group.

Further, although restricted cash is reported separately from other cash on the balance sheet, it still tends to be reported as part of a company’s overall cash balances. Thus, as restricted cash balances grow or decline, unrestricted cash goes in the opposite direction. “When restricted cash goes down, it’s freeing up unrestricted cash to do something else,” says Mulford, noting that changes in restricted cash balances have to be reported on the cash-flow statement.

Yet 20 out of the 41 companies studied didn’t record any such changes on their cash-flow statements. More significantly, from Mulford’s point of view, is that seven companies provided no explanation for the restrictions placed on cash. “How significant are these dead assets, these restricted cash assets that can’t be used for other purposes?” He asks. “For what purpose is the restriction?”

 Inconsistent Reporting

Currently, Generally Accepted Accounting Principles offer corporations no specific guidance about how to report the uses of restricted cash. Yet although Georgia Tech’s research “found that companies are for the most part doing a good job,” says Mulford, “we found some inconsistencies between what the restriction is and how it was reported in the statement of cash flows.”

In an attempt to resolve such inconsistencies, FASB is looking at improving the way restricted cash is reported as part of a project aimed at clarifying cash-flow accounting overall. “We do believe that there is diversity in practice in how changes in restricted cash are reported on the cash-flow statement. One possible approach we are evaluating is classifying the changes in restricted cash based on the nature of the restriction,” FASB Member Marc A. Siegel told CFO via email.

That classification approach seems to be buttressed by a Georgia Tech finding suggesting that there could be a limited number of reasons companies restrict cash. “We find a general consistency between the primary reasons for the restrictions placed on cash and the classification of the change in restricted cash on the statement of cash flows,” the report’s authors write.

“For example, among three firms that classify the change in restricted cash as an operating item, all three include operating-related actions, such as hedging activities, insurance claims or operational obligations, among the primary reasons for their restrictions on cash. Similarly, among the firms reporting the change in restricted cash as investing cash flow, most include investment purposes among the primary reasons for their cash restrictions,” they say.

Don’t expect FASB to completely overhaul cash-flow reporting, however. As with the other individually identified issues on the cash-flow project, which will also look at the reporting of insurance proceeds, debt prepayments and zero-coupon bonds, “we are not seeking to impose a separate rule for this specific cash flow classification issue,” says Siegel. “Instead, we are seeking a principles-based approach to solving specific issues such as the classification of changes in restricted cash.”