Risk Management

Corporate Cash: Hold and Release

Some finance executives – but not all – are once again allowing cash reserves to decline, according to two recent reports.

In January, 28 percent of finance executives told the Association for Financial Professionals that they would cut their cash holdings in the first quarter of 2013. It was the first time finance execs were forecasting lower cash reserves since 2011. Some of them followed through. But there were also plenty of companies that did what they have done for a decade: stockpile cash.

The latest “Corporate Cash Indicator” report, released by the AFP last week, showed that 28 percent of member organizations shed cash last quarter. But 38 percent amassed larger cash and short-term investment balances by the end of the period. The 10 percentage point difference was double that found in the AFP’s January survey. (The AFP did not disclose the number of members it surveyed.)

Year-on-year, though, there were signs of a reduction in U.S. corporate cash levels. Compared to January’s survey, April’s showed a much smaller difference between the percentage of companies whose cash holdings increased rather than decreased, according to the AFP.

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“The slower pace of cash accumulation is consistent with brighter outlook many companies have for the future,” the AFP stated in a press release.

The AFP’s take was somewhat consistent with an analysis of corporate cash by Fitch Ratings, released Wednesday. According to the report, “U.S. Corporate Cash Part I: Growth at an Inflection Point?” over the past decade corporate cash levels have greatly outpaced business activity. But they have stabilized more recently. Cash – the unencumbered and freely accessible kind – has outpaced growth in corporate sales by 50 percent to 80 percent since 2000 and 30 percent to 50 percent since year-end 2007. But in 2011 and 2012, median corporate cash growth rates approached zero, the ratings agency said.

Part of the reason for the decline: the large spike in cash balances at the onset of increased economic uncertainty in 2000 and 2008.

Still, U.S. companies seem not yet ready to let go of their large cash cushions. While the median cash growth rate measured by Fitch approached zero, 25 percent of U.S. industrial firms saw cash balances  rise by more than 25 percent in 2011 and 2012. And 23 percent of companies in the AFP survey said they anticipated expanding their cash and short-term investment balances in the next three months.

Fitch noted two macroeconomic reasons that U.S. non-financials continue to hold large cash balances. First, very low inflation lowers the opportunity cost of holding cash versus, for example, inventory. (Inventory value is more likely to keep pace with inflation.)

Second, says Fitch, capacity utilization – the measure of potential output levels – is still below the range – 80 percent to 85 percent – historically associated with economic expansions. Depending on the sector and company, “[the low utilization levels] may diminish incentives to invest for capacity expansion,” according to Fitch.

In addition, some industries – technology and pharmaceutical firms among them – have an inherent motivation to hold large amounts of cash reserves, the Fitch report points out.

In technology, for example, a cellular handset manufacturer needs to mitigate against material risks, like a sudden drop in average selling price, that are associated with making short-life-cycle products. In addition, “liquidity is particularly important for [a handset maker] enabling ongoing investments in R&D and leading-edge production capabilities through a downturn, often important in terms of driving down the unit cost,” according to Fitch.

In pharmaceuticals, low-leverage means large companies favor “operating with ample cash balances and liquidity sources to offset the high-risk and long-term nature of R&D, the potential for litigation and the effects of patent expiry.”

Anecdotally, the AFP said treasurers are “using cash balances to pay down debt, make capital expenditures and, in some cases, acquisitions.”

The AFP also found a slight uptick in companies that said they had become more aggressive with their short-term cash investments. Seven percent of organizations told AFP that they took on more risk with short-term cash last quarter, compared with 3 percent that said they were more conservative with investments. The four-percentage-point difference is up from zero the last two quarters of 2012.

The expiration of the Federal Deposit Insurance Corp.’s transaction account guarantee (TAG) program could be pushing treasury departments to seek some yield on their cash. According to bankers, many companies are still hoarding money in those operating accounts, but others are starting to sacrifice some portion of liquidity to obtain investment yield.

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