Fast Payments Hurt Tech Firm Cash Flows

A widespread cash flow drop among technology companies isn't a sign of trouble in the industry. Rather, it's the result of a shift in working capital practices.

Cash flow has been on the wane among technology companies for several quarters now, a potential cause of concern for investors who view cash flow as a measure of financial health. But a recent study says that the drop is primarily the result of faster payments to vendors, suggesting that tech firms still retain the ability to boost cash flow if necessary by increasing their payables.

Technology firms reported lower cash flow for an annual period ending March 2006, compared with the annual period ending in March 2005, according to a report by the Georgia Tech Financial Analysis Lab.

But an important factor in the reduced cash flow for the average technology company was the higher cash cycle, mostly caused by significant drops in days payables outstanding — the length of time companies take to pay their vendors. The cash cycle increased from 17 days for the year ending December 2005 to 29 days for the year ending March 2006. Payables days declined from 37 to 31 during the same time period.

“More of their revenue dollars were getting tied up in working capital,” observed Professor Charles Mulford, director of the Georgia Tech lab. “It tells me they have room to increase time to pay vendors in the future if they want, which would increase cash flow in the future.”

Most companies will take as long as possible to pay vendors, added Mulford. “Possibly they were offered discounts for paying earlier, or had sufficient cash balances and decided to use it and pay vendors more quickly,” he said.

The report based its study on the average technology firm, which was defined using the relative market capitalization of each firm in five general technology groups: computer hardware and peripherals, telecom equipment, computer software, information technology services, and semiconductors and related capital equipment.

All cash flow measures — core operating cash flow, operating cash flow, and free cash flow — declined during the annual periods studied. Core operating cash flow, generated by a company’s central operations, declined by 6.3 percent to $5.9 billion for the four quarters ending March 2006, compared with the four quarters ending December 2005. Operating cash flow declined by 6.9 percent to $5.1 billion, and free cash flow dropped by 7 percent to $4.0 billion.

One cash flow factor, revenue from core operations, declined by 2.2 percent for the year ending March 2006 to under $21.8 billion. Revenue for the average technology firm has remained below the $22.9 billion peak in the four quarters ending March 2003.

For these technology companies, the reduced cash flow warrants a closer look at its components for the complete picture of performance. “There is reason to be concerned about a drop in cash flow for this group of companies, but on the other hand, the fact that we see payable days declining as it did, I’m heartened by that,” says Mulford. “Here is an item companies can alter readily if they so choose.”

Discuss

Your email address will not be published. Required fields are marked *