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.
Attributes of a Good Cash Culture
After you have assessed your current organization, there are specific attributes of a future state that indicate if cash is part of the corporate culture.
- Your organization should have clear responsibilities for cash performance and delivery at all levels, but in particular for those that manage P&L.
- Senior and departmental management must have a good understanding of the cash levers within their business and what the current and historical metrics are against those levers.
- There should be clear cash targets for the business that are properly cascaded down to individual departments and individuals.
- Cash and working capital performance should be reported regularly and in a timely manner.
- Cash forecasting and re-setting of targets should be done regularly as well.
- There should be good operational and financial controls over cash and visibility into instances when these controls are not working
- The impact on cash should be considered when making key management decisions.
- Management incentive schemes should include a significant cash and working capital performance element.
- Management structures should be created to facilitate cash focus, e.g. a cash committee.
Managing cash is not simply about a set of quantitative measures. Effective businesses develop a cash culture as part of their corporate culture. Developing the culture starts at the top. Does this sound like the organization you are managing?
About the Author
Jonathan Collins writes the blog CFO Newsletter, where this article first appeared. He is a senior manager for KPMG China in Hong Kong. Combining a passion for finance and accounting, an enthusiasm for business improvement and deep experience in technology, Jonathan specializes in turnaround and improvement efforts for CFOs and CIOs. He can be reached at [email protected].