Cash Management

Show Me the Recovery

While second-quarter sales increases are encouraging, weak cash generation is worrisome.
David KatzSeptember 3, 2010

While U.S. companies have displayed slightly improved sales over the past two quarters, sluggish inventories and capital spending reveal a lack of conviction in the recovery, new data from a cash-flow study suggests.

To be sure, as of the quarter ending in June, signs of a comeback in the economy were starting to show up. For the second straight reporting period, median revenues for a sample of 3,807 public nonfinancial companies with market capitalizations of more than $50 million increased, according to a research report issued by the Georgia Tech Financial Analysis Lab earlier this week. Based on 12-month trailing periods, the median revenue figure grew to $542 million in the quarter ending in June from $528 million in March 2010 and $523 million in December 2009.

Similarly, operating cushion (operating profit before depreciation and amortization) also improved, rising to 14.96% in the second quarter from 14.84% in March 2010 and 14.63% in June 2009, according to the report, which analyzed data supplied by Cash Flow Analytics LLC. Even though such upticks are modest, they’re “encouraging” because they show positive movement over a six-month period, according to Charles Mulford, a Georgia Tech accounting professor and research director of Cash Flow Analytics. Further, since overall prices have held steady, the rise in revenues represents “real improvements in quantities being sold,” he says.

Nevertheless, companies are acting as if the increase in sales and profits isn’t sustainable. “If they truly believe that revenue growth is here to stay, we’d see inventories growing, and we’re not seeing that,” says Mulford. “We’d see increased capital spending, and we’re not seeing that.” For example, median inventory days remained relatively flat at around 26 in the second quarter of this year when compared with March, when the figure was about 24. In the quarter ending in June, median capex as a percentage of revenue was 2.79%, down from 2.83% in March 2010 and 3.76% in June 2009.


In their overall assessment of companies, the Georgia Tech researchers observed that firms continued to display a “hunker down,” attitude, “sheltering resources and shunning new investments in inventory and capital equipment.” Despite the increase in revenues, they “saw no evidence that firms were beginning to embrace growth or invest for the future. Instead, they appeared to be treading water, protecting their cash resources from future unknowns and waiting for a clearer economic picture to emerge.”

And those cash resources might be eroding. After a steady climb that began in the last quarter of 2008 and peaked at 6.69% in the first quarter of 2010, median free cash margin (free cash flow divided by revenue) decreased to 5.97% in the second quarter of this year.

Of the 20 industry sectors the researchers looked at in terms of free cash margin, 11 are stable and 4 are declining. “That’s 15 that are either stable or declining. If we generalize to the economy,” says Mulford, “we can say that there’s a lot of weakness in cash generation that’s starting to show up.”

The industries with declining median free cash margin in the second quarter were materials; transportation; consumer durables and apparel; household and personal products; and technology, hardware, and equipment. The sectors that saw a rise in their margins were commercial and professional services, automobiles and components, food and staples retailing, and health-care equipment and services.

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