Cash Scorecard: Unleash the Hoards?

Breaking a long-term trend, companies are slowly starting to let go of their cash stashes, new research suggests. The likely targets: share buybacks, dividends, business spending, and acquisitions.

But is the trend continuing in 2006? While Hackett will wait to tote up the score until all of this year’s results are in, a survey released in July by the Association for Financial Professionals suggests that many companies are still tightfisted. Forty percent of 342 corporate finance professionals surveyed in May said their companies carry a larger U.S. cash and short-term equivalent balance than they held six months earlier; 24 percent reported a decrease; and 36 percent said there was no change.

Indeed, 27 percent expected their companies to boost their cash balances over the next six months, according to the survey. About 25 percent think their organizations will let some cash go, while nearly half expect no change.

Even so, the parsimoniousness may be abating. Indeed, in a speech before the American Enterprise Institute in July, Federal Reserve Board Governor Kevin Warsh cited a change in business attitudes. Cash “has started to decline and borrowing has picked up,” he said.

During the past few quarters, cash-to-assets and cash-to-investment ratios have fallen, and the debt-to-asset ratio edged up in the first quarter of 2006, Warsh noted. The reason for the changes, he thinks, is growth in shareholder buybacks, dividend offerings, business spending, and corporate acquisitiveness.

To be sure, factors like the rise of terrorism and increased regulatory scrutiny in the form of Sarbanes-Oxley have made corporations unusually risk averse of late. Still, the Fed governor says, “it appears that firms are likely to continue to draw down their cash balances from the elevated levels witnessed during the past few years.”

Calculating the Cash

To put together The 2006 Cash Management Scorecard, Hackett-REL used public information reported by approximately 900 U.S. companies to calculate the returns that they would generate by using the excess cash on their balance sheets to pay down “capital employed.” For the purposes of the scorecard, the researchers define capital employed as short-term debt (including notes payable) plus long-term debt plus equity and cash as cash plus cash equivalents plus marketable securities.

To gauge the opportunity cost of retaining excess cash, they first figured out how much of a company’s cash exceeds its industry benchmark, which Hackett-REL determines to be the lowest quartile in a given industry as a percentage of sales. Then they subtracted that excess from the amount of capital a company employs. The company’s return on capital employed (ROCE), based on 2005 pretax operating profits, was then compared with what the return would be after excess cash is used to reduce the amount of capital employed.

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