Cash & Liquidity Management

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The Risks of Having Too Much Cash Cash is neither a static nor risk-free asset, and can easily turn from asset into headache. Although there are many benefits of holding onto it, it is crucial that the decision is made following a full analysis of the risks and costs involved.

The Risks of Having Too Much Cash

by Jason Torgler, Vice President, Strategy, Reval

Companies all around the world are awash with cash. According to the US Federal Reserve, American corporations held a record $2.05tr in cash as of mid-2011 [1]. At the end of last year Bloomberg reported that European companies held almost $700bn in cash [2], which is 16% higher than at the end of 2007 when the financial crisis first emerged. At the same time, a report from UBS said that some European companies have cash on their books roughly equal to 5% or more of their total assets [3]. Regardless of industry or region, corporations cannot be sanguine about these cash mountains; cash is an asset that needs to be rigorously tracked and risk-managed.

Although the current amounts of cash present numerous opportunities for corporations, there are also significant issues to consider. While it may seem counterintuitive that a company can suffer from being flush with cash, the risks that such excess poses are often overlooked. Excess cash can actually increase risk, offsetting the ostensible benefits of accumulating cash in the first place.

For companies with large cash balances the main issues that need to be addressed include:

Visibility and hedging. Generating and maintaining large international cash balances raises the importance of cash visibility and FX hedging. Large international banks have made enhancements to offer high-visibility, notional and physical cash management pooling programmes that centralise and optimise overseas subsidiary cash at the end of each day and hedge the net amount. World-class companies place a premium on managing their FX risk and invest in technology that keeps close tabs on the banks managing these pooling programmes.

Banks’ dwindling options. Basel III is forcing banks to collateralise their cash holdings. This is driving banks to limit cash and fund investment options. Limiting options will ultimately drive down yields or even push corporations toward non-stable investment options.

Tax considerations. Despite ongoing lobbying in the US for a ‘Homeland Investment Act 2.0’, American multinationals should not make their plans contingent on a tax holiday. While many developed countries, such as Japan and the UK, have territorial tax systems, which leave overseas profits to be taxed in the jurisdictions in which they are generated, the US has not followed suit. This means cash held overseas by US multinationals remains subject to a 35% tax rate, if repatriated to the US. Companies have issued debt to avoid this—even to fund dividends and buybacks—making it slightly less attractive to keep the cash abroad. But as long as rates stay low, there will be little impetus to bring the cash home.

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