Corporations Have Too Much Cash

There’s an old saying that anyone with a business degree has heard: in uncertain times, cash is king. And it’s true in one sense. In a bad economy, companies that have sufficient cash resources will find that they can move beyond competitors, gain market share, and even undertake opportunistic acquisitions at bargain prices.

But it takes some experience to learn that there is such a thing as having too much cash. Many companies in the U.S. are actually hording cash, according REL Consulting, which is a division of The Hackett Group, a management consulting firm. The 1,000 largest public companies in the U.S. were sitting on an estimated $853 billion in cash reserves at the end of 2010. That was $780 billion in excess working capital. Companies didn’t get the vast reserves — which were up 75 percent since 2005 — through improved working capital management. That improved by only 2 percent over 2009. Much of it was due to revenue growth combined with concerns about markets and customer demand, because the economy still hasn’t fully recovered.

Furthermore, debt significantly increased in 2010. Among AAA-rated companies, debt increased by 30 percent over the past five years. Because interest rates are low, companies have borrowed just to have cash on hand. What’s the problem? Cash is just another resource. When hoarded, it does little good and drives down return on investment for companies.

Think of it as similar to inventory. Companies have spent years learning to optimize the amount of inventory they have. Too little, and you can’t meet the needs of the business. Too much, and you tie up money and become unable to invest and use it to gain more profit.

Hoarding cash is exactly the same. Have too little, and you can’t take advantage of opportunities. However, stockpile too much and you don’t put it to work so it can generate profits. There’s an additional problem in borrowing to keep more cash on hand. Even though interest rates are low, they are above zero and likely higher than the interest companies receive on the cash.

So it’s a case of negative arbitrage, where the corporations probably actively lose money by letting it sit. Finally, if companies are being inefficient in how they manage their cash, then the massive amounts of cash on hand will only mask the problem. So there’s an additional opportunity cost the companies must bear. Here are some of the suggestions REL offers to improve the situation:

  • “Make working capital optimization and cash flow improvement a strategic priority, with visible senior executive backing. “
  • “Link cash flow performance and working capital management to the compensation structure.”
  • “Make cash flow one of the key metrics for performance management within operations as well as finance.”
  • “Invest in improving demand forecasting and deployment of effective sales and operations planning process.”
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