There are some astonishing statistics on the amount of cash held by non-financial firms.
Around the end of 2013, the average FTSE 100 company held £1.9 billion, US non-financial firms held USD 1.64 trillion, all at record levels. It is worth looking at this from both a corporate finance angle and for what it means for the role of the treasurer.
For many years, all corporate financiers have been taught (broadly courtesy of Modigliani and Miller) that leverage improves the return on equity, essentially by being able to do more with less of our own (equity) capital. So utility companies, property companies and industrials (among many others) have loaded themselves with debt to achieve this.
Modigliani and Miller even tell us how to find an optimal level of leverage by using the concept of Weighted Average Cost of Capital and minimising this. It’s not the only way to decide leverage, and methods such as multiples to work out debt capacity are also popular and easy. Pecking Order Theory, another method, tells us that managers go to the next easiest source of capital if they need money for a project.
So having all this cash seems to be the wrong thing to do as it makes the balance sheet less efficient. These companies are effectively raising either debt or equity (both of which have a cost) and putting it back into the market at near enough zero return and carry counterparty risk with it as well. Why?
There are plenty of possible reasons, such as:
• Taking advantage of cheap debt
• Not wanting to rely on financial markets for liquidity
• To reduce risk if losses are suffered on a project
• Possible tax claims (including tax payable on repatriation of some funds)
• Possible collateral for derivatives
• A desire for ‘robustness’ in the face of uncertainty
Some of these imply that future projects are planned, but not yet. However theory tells us that profitable projects should always be financeable.
We also need to bring in sector to the equation here, not always considered in classical corporate finance. Broadly a firm with stable and non-risky cash flows can accommodate high levels of debt as the stable cash flow will service the debt. Indeed such firms need to lever up to increase risk sufficiently to encourage equity investors to participate. So property and utility companies with stable incomes will lever up heavily. Equally, risky companies should do the opposite and have spare cash to reduce the riskiness and make the equity investment acceptable. Thus a technology company, whose whole future rests on their next product, needs spare cash to cushion the problems if that next product fails and they can then go on to try yet another product. This is why the technology companies such as Apple and Microsoft have such huge cash piles, or at least perhaps part of the explanation. Indeed any start-up, which is by definition risky, should never use debt finance, and a key measure in these companies is how long they can live with their current cash holdings.
However there is no doubt that there is probably too much caution and too much cash sitting inside companies. This cash has attracted the attention of equity investors, who in fact really own this money. ‘Activist’ investors, such as Carl Icahn at Apple, and others at Sotheby’s, just two examples, have pressured management to return cash to shareholders. There is perhaps another Pecking Order Theory going on here. Management will sit on the cash, doing the easiest thing, until someone makes their life difficult.
How does this affect the treasurer? Many treasurers were brought up in the times when the main role was to find debt capital to keep the business going. Utilities are constantly in the markets, looking for good opportunities. These treasurers also hated the cost of carry, where cash could not be applied to debt and the margin on that debt seemed like a waste of money. This lead to centralisation in treasuries and efficiencies in cash management. Debt was also long term, so there was no day to day pressure to raise money (except perhaps in very high grade commercial paper funded companies). Cash, however, is invested for very short periods, so there is day to day pressure to find homes for the cash and move it around. With low interest rates, it’s also less important to centralise cash. So the treasurer becomes a counterparty risk manager.
The treasurer must ensure that this cash is available to fund the business and the well-known mantra SLY (Security, Liquidity, Yield) is important to apply, but the treasurer should also be curious around the capital structure and not be afraid to ask why this is happening.
