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Why Your Firm Should Have a Strong Cash Culture

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Why Your Firm Should Have a Strong Cash Culture

by Jonathan Collins, 05 August 2011
topics:
Banking and Finance Cash and Liquidity Management
tags:
cash management treasury management what is CFO what is treasurer working capital survey

The Great Recession of 2008 caused many companies to focus on cash above all else as sales and profits vanished. That seems to have worked out quite well – the 2011 CFO.com survey on working capital indicates that companies in the US and elsewhere are now sitting on record levels of cash.

 
Should CFOs now pay less attention to cash and focus on other priorities? While some companies would look at the amount of cash on the balance sheet and feel comfortable, establishing a cash culture is actually more important than ever.
 
Cost of Capital
Cash is an essential component of financing future growth. Inefficient cash management can result in a higher than necessary cost of capital and a reduction in the ROI to shareholders.
 
Breaking apart the cost of capital and looking specifically at debt, having a strong cash position on the balance sheet can result in more options for debt financing. Risk is the biggest factor when determining a company’s cost of capital and having a strong cash position can significantly lower the risk of borrowing and therefore the cost of borrowing.
 
The Association of Financial Professionals has found that companies are sitting on large amounts of cash as a result of not knowing their cost of capital. The effect of using a higher than necessary cost of capital in capital budgeting can result in companies not accepting projects for growth that they would have accepted using lower cost of capital measures (i.e. a higher cost of capital will result in higher hurdle rates for capital investment projects).
 
Therefore companies are choosing to sit on cash rather than invest it in capital improvement projects. The obvious effect of not taking on strategic projects for firms seeking growth is a lower ROI to shareholders.
 
Are You Managing Cash Effectively?
Determining whether you have a cash culture begins with an assessment of how effectively you are managing cash today.
 
While there are plenty of quantitative measures available, including macro measures found in the CFO.com working capital survey, a proper assessment should include qualitative measures, including questions such as:
 
  • Is the focus of management purely on external financial measures (i.e. those reported analysts) such as sales, profit, and EBITDA?
  • Are divisions measured solely on operating profit rather than cash flows?
  • Is cash forecasting report produced and reviewed routinely? Is the information timely or dated? Is the information complete and accurate? Are actions from the review documented and tracked?
  • Is working capital managed? Similar to cash forecasting, is a working capital report produced and reviewed routinely?
  • How is the role of treasurer defined? Is it narrowly defined such that the treasurer is only responsible for the relationships with the company’s bankers?
  • Is an overwhelming majority of funding sources for your business non-cash? Businesses with plentiful non-cash funding sources tend not to have a cash culture.

 

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