When Less Cash Is a Good Thing

Registering a slight boost in capital expenditures, companies may be starting to display belief in an economic recovery.
David KatzJanuary 20, 2011

While most companies continue to hoard their cash as if they were still mired in a recession, they have ever so slightly begun to loosen their purse strings, new research suggests.

For the 12 months ending with the third quarter of 2010, median free cash margin (free cash flow divided by revenue) continued its dip from a recent high of 7.18% in March 2010, according to the Georgia Tech Financial Analysis Lab’s latest report on cash-flow trends at nearly 3,000 nonfinancial public companies. Free cash margin fell to 6.18% in the third quarter of 2010 from 6.71% in the second quarter.

To be sure, corporate free cash margins are still abnormally high. Following a decade low of 2.43% in March 2001, median free cash margins hovered between 4% and 5% for more than six years before reaching a recent low of 3.96% in December 2008. After that, companies began to cut expenses, injecting higher and higher percentages of revenue into free cash flow.

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Besides cutting their payrolls, companies managed to shore up cash during the recession by slashing their capital expenditures. Lately, however, median corporate capex as a percentage of revenue has risen a tad, to 2.77% in the third quarter of 2010 from 2.65% in the previous quarter. That increase in capex drove the decline in free cash margin, according to the lab’s report.

Still, the tiny rise in median corporate spending on such things as building and refurbishing plants and equipment was from a 10-year low of 2.61% reached in March 2010. “If there’s anything of a surprise [in the study] it’s that companies haven’t begun to grow capex like we expected yet. They’re still hanging on to cash,” says Charles Mulford, the lab’s director and a professor of accounting at Georgia Tech. He says that capex should have risen to about 4% of revenue by now.

Executives “are still managing their businesses as though we’re still in a recession,” observes Mulford, noting they are as tight-fisted with operating outlays as they are with capex. “They’re doing what a household would do when it’s concerned about the future. They’re holding back.”

A main reason that free cash margin has decreased of late is that revenues have remained flat. From September 2009 through March 2010, median revenues hovered near $500 million, according to the report. Further, because spending has inched up and sales have stayed constant, there’s a bit less cash left over to invest in the company or turn over to shareholders in the form of share buybacks or dividends.

Slight as the rise in free cash margin is, though, it may be a harbinger of a return to normalcy, according to the professor. “We’ll know we’re back to normal when revenues are growing,” says Mulford, “and cash balances start to come down.”