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The cash paradox: How cash levels can affect corporate behavior
In the coming years, companies should consider finding a way to thrive in a new economic reality characterized by below-average growth conditions and shorter, but more volatile, economic cycles. In such conditions, pursuing growth opportunities may be less about earnings-per-share enhancement and more about long-term prospects.
During the financial crisis, many CFOs served their companies well with financial prudence and by accumulating cash. Now that many companies are refocused on growth, market commentators frequently cite these record cash figures as a key indicator that capital expenditure (
According to a recent analysis by Deloitte LLP (see “The Cash Paradox: How Record Cash Reserves Are Influencing Corporate Behavior”*), there is an uneven distribution of those cash levels. While at the end of 2013 the S&P Global 1,200 public nonfinancial companies held $3.53 trillion in cash reserves,1,2 just 32 percent of the companies held 81 percent of the cash reserves (see figure 1).3
Moreover, these “large
While it is important to note that the terms “large” or “small” cash-holding companies do not imply that they are also large or small by market capitalization, there are lessons in the research for companies of all sizes. And in this issue of CFO Insights, we’ll discuss the findings and their potential implications for corporate cash strategies.
*Article adapted from “The Cash Paradox: How Record Cash Reserves Are Influencing Corporate Behavior,” Deloitte Review, July 2014.
Behind the record buildups
Corporate-sector leverage, aided by a vibrant financial sector, helped fuel the precrisis boom. The subsequent shift of debt from the corporate and financial sector to the government following the high-profile government-led bailouts is one of the defining consequences of the financial
As a result, the corporate sector built up record levels of cash reserves. US companies are the largest constituent of the S&P Global 1,200, and with $1.6 trillion in cash reserves, they account for 45 percent of the total reserves for the index. Then come Japanese companies, which account for 14 percent of the cash reserves globally, followed by companies based in France, Germany, and the UK.7
But cash levels have not typically followed the Pareto Principle, also known as the 80/20 rule—the phenomenon whereby the greatest impact (typically 80 percent) is attributable to the vital few (generally 20 percent). According to Deloitte’s research, at the height of the precrisis boom in 2007, the large
Surprisingly, the large
Ways companies spend their cash
The research also considers the spending patterns of these two sets of companies by analyzing their capital expenditure as a proportion of cash from operations and their M&A spending as a proportion of cash reserves to understand how these companies allocate their cash.
Capex: In the last couple of years, both the large and the small cash-holding companies increased their capital expenditure, suggesting they have confidence in their ability to generate cash. 10 The large
M&A: Since 2009, the large
Divergence in performance
The divergent attitudes toward cash accumulation and spending gain more context when the relative performances of both sets of companies are considered. Both sets of companies grew their revenues at a consistent pace since 2000, but there was a clear divergence after the financial downturn, when the small cash-holding companies grew revenues at a faster pace than their larger counterparts. In part, this can be attributed to
At the same time, a divergence in share price between the cash hoarders and the spenders has also emerged (see Figure 2). Since 2000, the share price performance of the small cash-holding companies has outperformed their large
In the coming years, companies should consider finding a way to thrive in a new economic reality characterized by below-average growth conditions and shorter, but more volatile, economic cycles. In such conditions, pursuing growth opportunities may be less about earnings-per-share enhancement and more about long-term prospects. Therefore, in pursuing opportunities, corporate leaders, including CFOs, may want to make a combined assessment of their company’s relative strategic capability, which can indicate its ability to capture growth, as well as its financial strength, which may reveal its ability to fund future growth opportunities. And they should keep the lessons of the research in mind: whereas financial conservatism served companies well during the downturn, in times of economic recovery it could be a double-edged sword, dragging companies into a cycle of cash accumulation at the expense of investing in growth.
1“Cash reserves” refers to cash and near-cash items and marketable securities and other short-term investments. Companies considered for the analysis are the non-financial constituents of the S&P Global 1,200 that had reported their 2013 results as of April 8, 2014. The constituents are as of March 6, 2014.
2Deloitte calculations based on Bloomberg data, accessed April 8, 2014.
4“Large cash-holding companies” are defined as those with cash reserves of, or in excess of, $2.5 billion at the end of
5Deloitte calculations based on Bloomberg data, accessed April 8, 2014.
6“The Cash Paradox: How Record Cash Reserves Are Influencing Corporate Behavior” Deloitte Review, July 2014.
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