The Cash-Rich CFO: Managing the Money -- and Expectations

In today’s uncertain economic environment, cash accumulation is a prudent strategy. Large cash reserves can act as a safeguard against a future downturn, while building a war chest for future investments once the worst of the crisis is past.
This cycle of cash accumulation is unlikely to be broken any time soon. “Until companies see that consumers are starting to spend and other companies are starting to invest, I think they will be very reluctant to pre-empt the market by starting to spend the cash they have on their balance sheets,” says Dougald Middleton, Ernst & Young’s Head of Lead Advisory Services, UK & Ireland.
But large cash balances in today’s volatile economy create new challenges for CFOs. Cash that would once have been earmarked for acquisitions and other strategic ventures is now lying idle and earning tiny returns in low-interest instruments.
To keep cash at the ready in the event of a downturn, companies are avoiding long-term investments. And, since the downgrading of many prominent banks over recent years, even traditionally secure short-term investments instill less confidence than previously.
For CFOs in this situation, there are challenges and there are opportunities. In this report, we explore the key considerations for finance leaders of cash-rich corporates.
Invest, pay out or buy back
Ultimately, cash-rich companies face a choice. Either they can invest their surplus cash and put it to productive use, or they can return it to shareholders in the form of dividends or share buybacks. For now, companies seem to be favoring the latter, particularly by multinationals such as Nike, AT&T, Siemens and Apple.
Share buybacks can help to shore up asset prices in the short term. Companies that have fared well during the downturn and do not trust the other available investment instruments might well choose to back their own company’s profits by buying back shares.
But this is hardly a sustainable growth strategy. Indeed, some analysts have argued that share buybacks often end up destroying value, particularly if the company pays less than the intrinsic value of the shares.
For Richard Davies, Managing Director of investor relations consultancy RD:IR, the dilemma for cash-rich companies stems from the fact that they have not yet become accustomed to the new economic landscape.
“There should be a growing realization that things aren’t going to bounce back in the way they traditionally have in previous boom and bust cycles,” he says. “That means that companies should start to lower their sights in terms of what is available in the form of investable opportunities.”
“This would spell a strengthening trend of cash-rich companies snapping up those that are cash-poor, given the amounts of cash available on balance sheets and the low valuation of many targets on a fundamental basis.”
Explain your cash-rich position
The rationale for holding large quantities of cash on the balance sheet will vary from company to company. Some may have chosen to build up their cash reserves to increase their resilience against further economic strife, while others have done so on the assumption that a large-scale strategic move is imminent.
Others have simply been so spooked by financial crises that they never want to be in a cash-poor position again.
But the market may not be as understanding of a strategy which prioritizes cash over growth, unless the rationale is communicated convincingly. “Companies need to articulate their story clearly and explain to shareholders why they are sitting on that pile of cash,” says Les Clifford, Chair of Ernst & Young’s CFO Program in the UK and Ireland. “Very often, companies are not clear enough about the rationale for their balance sheet position, and that creates uncertainty and concern among the investor base.”
By communicating regularly with investors about their perceptions of their markets, and how their financing decisions reflect that, CFOs can build strong, long-term relationships with shareholders based around a clear premise of “no surprises.” And ultimately, argues Mr. Davies, this leads to a more stable shareholding base and better longer-term valuations.
“The evidence suggests that those companies that talk to shareholders, tell them about their strategy and communicate their business model fully and transparently, even if the numbers aren’t great, have a better valuation over time than those that don’t,” he says.
Lock in finance at record rates 
For CFOs of investment-grade companies in countries with a relatively sound economic footing, it has never been easier or cheaper to sell bonds. Investors need to find a safe haven for their cash, and this has brought down borrowing costs to unprecedented levels.
While it may be counter-intuitive for cash-rich companies to issue bonds that will further bolster their cash reserves, some CFOs of cash-rich companies are doing just that, in order to lock in finance at historically low rates.
Develop a clear treasury risk management strategy
Over the past few years, the role of the treasury department has seen a shift in focus. No longer are its professionals expected to find ways to create wealth and profits — instead, there is a real focus on identifying and mitigating risk.
The governance of treasury management has come to the fore, with many companies putting in place clear policies and strategies to ensure that the board and audit committee are comfortable with the risks being taken.
Diversification of banking relationships is essential. Although many banks around the world are now on a stronger footing than they were in 2010, CFOs should ensure that their treasury departments diversify their banking relationships to limit the exposure to any single institution.
“We see continuing concerns among corporates about counterparty risk in their banking relationships and this is encouraging many to diversify their holdings,” says Olivier Drion, EMEIA Head of Treasury Services at Ernst & Young. “They are seeking to reduce as much as possible the maturity of deposits, as well as spread their risk across banks and into other vehicles such as money market funds and mutual funds. “
Country and currency risks are critical factors to manage. CFOs are having to factor country and currency risks into their investment decisions. “Finding the right banks to invest in is really becoming a burden even if you’re willing to cross borders,” says Tanguy Coatmellec, EMEIA Head of Treasury Advisory at Ernst & Young.
Moving money into a more secure currency may not necessarily be a wise move either. “If your costs are in one jurisdiction and you move your cash or debt into a different currency, you add some currency risk to your balance sheet and your profit and loss,” says Mr. Coatmellec.
“We are seeing companies working to keep their resources in the same currency in which they generate their Earnings Before Interest and Tax (EBIT). For example, an international company which generates 50% of its EBIT in dollars might try to keep an equivalent amount of its debt and reserves in dollars as well, to ensure consistency in case there are significant fluctuations in one currency or the other.”
Reconsider the role of the treasury professional. The importance of treasury risk management to the health of the business also means that CFOs should think more carefully about the skills and backgrounds of the executives who populate the treasury department.
A growing number of companies are focusing on the recruitment of specialists who have a deep understanding of the instruments used, rather than rotating general finance professionals into the role.
“In the past, the treasury function was often run by somebody in finance and the role was seen as a stepping post onto a bigger finance role,” says Mr. Clifford. “Today, there is a much greater focus on ensuring that the team has deep knowledge and understanding and is able to advise on procuring better banking and fund-raising relationships.”
Support your supply chain
A cash-rich company does not necessarily have cash-rich suppliers. Suppliers may be small or medium-sized enterprises (SMEs), which are typically finding it much more difficult than investment-grade companies to access finance in the current environment.
Where finance is available, it is often expensive, which has a knock-on effect on the prices that the supplier charges to the customer. Suppliers may also be facing cash-flow problems of their own because some customers may be extending supplier payment terms or delaying payment in order to improve their cash flow.
Many large companies are utterly reliant on a small number of key suppliers within their supply chain. If one of those providers becomes insolvent, the company may be unable to get its products to market or even to operate.
Supplier finance options. A growing number of cash-rich companies are exploring a range of supplier finance options, which allow suppliers to get early payment on their invoices in return for a financing charge.
“Supplier finance has traditionally been used as a way for a company to support its suppliers while extending their credit terms,” explains Jon Morris, EMEIA leader of Ernst & Young’s Working Capital Services. “But it is also seen as a means to help smaller suppliers by giving them cash flow flexibility, which is financed at a lower cost of capital.”
What’s more, some of these approaches can help cash-rich companies to earn a yield in excess of what is possible from a cash account.
  • Reverse factoring. With this approach, the customer presents invoices from a supplier to a third-party factor, usually a bank, which approves them for early payment. The suppliers can then choose to draw down early payment for some or all of the invoices in return for a discount on the payment. The supplier benefits by being able to receive early payment for some of its invoices, while the customer can maintain the original payment terms, because it is the bank that finances the early payment and earns the discount as commission.
  • Dynamic discounting. In this more direct approach, there is no third-party bank or factor, and the customer simply accelerates payment for invoices to the supplier in return for a discount. The size of the discount may be small — possibly only around 1% — but it will be greater than the return on cash that could be earned by simply leaving these funds in a low-return liquidity vehicle. Suppliers also benefit by gaining access to earlier payment and addressing their liquidity problems.
Consider supporting your customers. Cash-rich companies can use a similar mechanism with their own customers. “If you are in a strong cash position, you can get your customers to pay you a little later, provided you’re happy to carry the risk of default,” explains Mr. Morris.
“You might then offer your customer a facility to pay in 60 days, rather than 30, but require them to pay a little more in return.”
Some companies are providing credit to their customers in order to support their core business. Google, for example, plans to offer a credit card to customers, which will provide a low-interest-rate credit line of between US$200 and US$100,000 a month. Amazon has a similar scheme offering loans to sellers of products on its marketplace.
But don’t be imprudent. It makes sense for companies to undertake initiatives that strengthen the supply chain, but Mr. Clifford advises them to ensure that they do not expose themselves to unwanted risk.
“If you’ve got key suppliers facing potential liquidity problems, then using some of your surplus cash to provide security to them and de-risk your business has to be a good idea,” he says. “But it should only be done where it makes commercial and strategic sense and once you have gone through a rigorous due diligence process.”
Keep your eyes open to M&A opportunities
With slow growth predicted in the global economy for some time to come, few companies have the appetite — or see the urgency — for major M&A deals. But this cycle will eventually turn, and the cash-rich companies will be the ones best placed to move quickly and acquire prime assets.
Buy out the competition. One option open to cash-rich companies is to buy, rather than build, capacity. In other words, cash-rich companies may lack the appetite for bold, transformational deals, but there are numerous opportunities to use smaller acquisitions to increase market share and take out competitors.
“If you look at any recession, there is always corporate takeover activity based on rationalizing competitive pressure in the market,” says Mr. Middleton.
“So if you’ve gone through the process of making operational improvements, cleaning up your balance sheet and conducting share buybacks, the next logical step is to buy capacity in order to take out competitors in the market.”
Seek out the unloved assets of others. The past few years have seen companies everywhere reconsider their competitive strengths and make difficult decisions about where their core competencies lie. Many companies have come under pressure from shareholders to focus on a narrower set of business priorities.
At the same time, the disposal of non-core assets through a divestment or carve-out process is, for companies in a less fortunate cash position, a quick and relatively easy way to raise finance. Acquiring these unwanted assets can be a powerful opportunity for cash-rich companies, particularly if there is a neat strategic fit with their own business.
One of the reasons why a company divests a non-core asset is because it does not believe it has the resources, capability or know-how to get the most out of it. This is something that private equity acquirers have known for a long time, but any company can apply the same logic.
The CFO’s role
Ernst & Young has developed the CFO wheel, which we  believe represents the breadth of the CFO’s remit (see chart below).
Click image to enlarge
We outline actions for CFOs of cash-rich companies to consider, as they relate to Ernst & Young’s CFO wheel , which is our way of illustrating the core components of the job.
1. Trusting the numbers
  • Work with the CEO and management team to determine appropriate opportunities for investing surplus cash
  • Identify risks in business proposals
  • If the time is not right or risks too great, be ready to challenge key business stakeholders
2. Providing insight
  • Communicate financial information clearly to internal stakeholders
  • Provide evaluation of the key risks and opportunities
  • Analyze market trends to determine whether to invest, return cash to shareholders, or continue to increase cash holdings


3. Getting your house in order
  • Ensure that the right skills are in place in key finance functions, including treasury risk management
  • Explore options for supplier financing
  • Assess whether surplus cash can be used to drive internal improvements, including within the finance department
4. Funding organizational strategy
  • Determine the best approach to long-term funding
  • Take advantage of highly liquid bond markets
  • Determine the right mix of different funding types for investments
5. Developing business strategy
  • Analyze opportunities and create a business case for investing or not investing
  • Allocate resources to appropriate internal and external investments
  • Work with C-suite colleagues to design appropriate business and operating models
6. Communicating to the external marketplace
  • Communicate clearly the rationale for the company’s cash position to external investors
  • Articulate why a strong cash position is good for the business
  • If the company is not investing, explain why not


About the Author

Ernst & Young is a global leader in assurance, tax, transaction and advisory services. This article is an excerpt from “Drought or Drowning? Cash Challenges for CFOs at Both Ends of the Liquidity Spectrum,” which is Volume 4 of The Master CFO Series. It has been re-edited for clarity and conciseness. © 2012 EYGM Limited. All Rights Reserved.


Photo credit: Shutterstock


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