With credit markets iffy and nervous investors searching for conservative balance sheets, companies are looking to shore up liquidity.
When the going gets tough, survivors hoard liquidity. It's one of those core truths battle-tested CFOs teach their assistants, and it's a message that's heard often these days. Having been burned by phantom earnings posted by Enron and similarly disastrous ventures, investors are looking for companies with solid piles of cash or assured access to credit to tide them over whatever rough spots lie ahead. But suppliers of liquidity -- from bankers to commercial paper buyers -- have a nervous hand on the spigot.
Corporate finance executives are already complaining that cash is in short supply. That may be a matter more of perception than reality, according to Michael Swanson, senior economist at Wells Fargo Bank, Minneapolis. An abundance of liquidity is sloshing through the U.S. banking system because the Fed has pumped up the money supply far above demand, causing prices -- interest rates -- to fall. But banks, wary of escalating risks, have raised their lending standards substantially, widening credit spreads and cutting off a growing group of marginal borrowers, he explains.
For a long time, the favored corporate strategy was to keep as little cash as possible on the balance sheet, says Peter Sereda, vice president and treasurer of Telephone & Data Systems Inc. in Chicago. "You almost always paid more for your debt than you earned on your cash, so cash was a drag on financial performance. You used it to pay down debt and eliminate the negative arbitrage." Credit facilities ensured future liquidity.
But in today's tight credit market, the thinking has changed. "We're hearing from rating agencies that our liquidity position counts a lot in the ratings decision now, and investment bankers are saying that liquidity definitely affects stock prices," Sereda notes. "Revolvers have become rainy-day funds. The bank market is extremely difficult; you can't count on that credit being there several years out when the revolver comes up for renewal."
To protect its liquidity reserves, Telephone & Data Systems has scaled back its use of bank revolvers and begun to "prefund" future expenditures with long-term bonds, stretching maturities as far as possible. "A year ago, we did a 40-year bond deal; then we did another one for 30 years," Sereda reports. "With our heavy capital expenditures, we have to hold a long-term perspective and take steps to assure our future liquidity. That means carrying larger precautionary cash balances than we have in the past."
Corporations that enjoy solid, long-term banking relationships used to take liquidity for granted, but they can no longer do so, cautions Robert H. Hamilton, senior vice president of Wachovia Bank's treasury consulting group in Atlanta. "Some long-term corporate customers have been dumped by their banks," he says. "Everyone has heard these stories, so there is widespread concern that the company's credit banks might not be there when they are needed."
Companies searching for external sources of liquidity must sell themselves as worthy borrowers to increasingly skeptical bankers and inves-tors. During the long bull market, investors bet heavily on long-term prospects and hot technology plays. Amazon.com Inc.'s market capitalization sometimes exceeded that of giants like General Electric Co., recalls Stephen M. Payne, CEO of working capital management advisers REL Consultancy Group in Purchase, N.Y. The same powerful forces briefly made Enron the nation's seventh largest company. But now investors are keying in on fundamentals, and cash carries more weight than rosy prospects.
In response to heightened emphasis on integrity and visibility in accounting standards, corporations are changing the way they account for cash, Hamilton reports. Businesses are relying more on actual bank balances, he says, than on "what accountants think should be there, based on accounting information." Companies probably gain little or no credit with investors and ana-lysts for this practice, but a defensive approach to cash accounting helps businesses avoid the damage that material misstatements and cash restatements can cause, he adds.
Buying liquidity in the marketplace -- selling commercial paper, factoring receivables, securitizing assets -- is a valid strategy. But the more liquidity a company can squeeze out of its financial operations -- for example, by paring back inventory and expediting collections -- the less it will have to depend on iffy providers, Payne notes.
"Just by improving the fundamental ways a company does business, we've seen cash flow improve by 25 to 35 percent," Payne says. Cleaner receivables not only reduce the need to borrow, but also let companies negotiate lower rates for any borrowing that they may still need, he adds.
Extending payment terms may be necessary to compete in lean times, Payne admits, but CFOs must factor the cost of that strategy into their decisions. Consider paying lower commissions for sales arranged on extended terms than for those made on standard terms, he suggests. Companies should pay sales commissions when customers pay for goods or services, not when they order them. And if you offer extended terms, emphasize that you expect to be paid on time, and don't wait until an invoice is 10 or 15 days past due to start collection calls, he advises.
Close attention to days sales outstanding (DSO) can help companies "turn trash into cash," says Jerry Curtis, president and CEO of NRS Outsourcing, Carrollton, Texas. The gap between a sloppy DSO and the industry standard can be closed with the right effort. "A firm with 64 days DSO where the industry standard is 48 days can pick up 16 days," he notes. That's money the company won't have to borrow at asset-backed rates well over prime. Curtis' best results to date have reduced client companies' DSO by only five days, but he points out that one of his large customers saves $1.2 million in borrowing costs for each day of DSO it can shed.
With corporate financial performance now under analysts' microscopes, companies are redoubling efforts to reduce pricey working capital tied up in receivables and improve their ability to forecast incoming cash in order to borrow more precisely and economically, says Veena Gundavelli, president and CEO of cash flow management software provider Emagia Corp., Santa Clara, Calif. "If you see that you'll need $200 million but can predict with some certainty that $100 million will arrive in time, you can eliminate most of that $100 million of excess borrowing," she explains. Software packages can provide sophisticated forecasts based on historical patterns and update them in real time as collectors call key accounts and find out when to expect payment, she notes.
Companies are seeing excellent results from their liquidity-building campaigns. Last year, Corn Products International Inc., headquartered in Westchester, Ill., boosted cash flow by $40 million across its five subsidiaries in the United States, Mexico, Canada, Argentina and Brazil by achieving tighter management of inventory, A/R and A/P, says Cheryl Beebe, vice president and corporate treasurer. She attributes much of the success of the working-capital reduction project to the commitment of chairman, president and CEO Sam Scott, who gave the initiative high priority.
A particularly bright spot was a 50 percent reduction of DSO in Argentina, Beebe reports. Corn Products reacted quickly to deteriorating market conditions in that troubled economy by tightening its collection process and discontinuing sales on 120- to 150-day terms.
Improved liquidity management was critical to the $100 million that Corn Products lopped off its debt in 2002. Low interest rates make debt relatively inexpensive in the United States, but in some Latin American markets the company pays as much as 21 percent, Beebe notes.
The drive to improve liquidity positions by drawing on internal resources has sparked interest in sophisticated cash management solutions. Global corporations are focusing on unproductive balances in bank accounts scattered around the world and seeking ways to use those funds to pay down debt, says Vicki Grunski, head of global liquidity products at Citibank in New York City. These organizations are turning to banks that offer notional pooling to offset debit and credit positions and ensure that all monies are invested.
Alternatively, rather than spending time and resources chasing overseas balances, global com-panies can outsource offshore cash management to banks that use sweep accounts to invest cash surpluses automatically, Grunski notes. Increasingly, corporations that formerly pooled liquidity by region are seeking global solutions, capitalizing on recent initiatives by countries in Europe and Asia to remove restrictions on the flow of money across borders, she reports.
Finance executives know that, in the words of the resilient Scarlett O'Hara, "Tomorrow is another day." But only for corporations that maintain adequate liquidity reserves. When cash runs out, there is no tomorrow. And that's why prudent companies are building the enhanced liquidity positions that will ensure a brighter future.
The P-Card AdvantageCorporate purchasing cards, adopted to streamline the purchasing process, are proving an important ally in companies' efforts to build and conserve liquidity. Sellers receive payment within 48 hours for card transactions -- a gain in liquidity that offsets the discount they pay to their banks and transaction processors. Because sellers put a premium on liquidity these days, they are often happy to negotiate lower prices for card transactions, experts say. Whether buyers gain or lose float is less certain. If they pay a bank in 30 days instead of paying various suppliers in the same period, it's pretty much a wash, says Chris Pieroth, senior vice president for product and marketing in the corporate payment systems group of U.S. Bank, Minneapolis. However, it's generally harder to stall payments to a bank. When buying organizations use the card primarily with incidental suppliers, and there are no contractual payment terms, invoices are usually forwarded to A/P and paid in the next cycle, observes Walt Hazelton, research director for The Hackett Group, Atlanta. In that case, buyers probably pick up float and bolster liquidity. Sharp finance pros occasionally exploit the system to achieve large float gains. Richard Palmer, Lumpkin distinguished professor of business at Eastern Illinois University, Charleston, Ill., reports that one organization he knows has negotiated 30-day terms with most of its suppliers. When invoices arrive by mail, the company waits until the due date before paying by p-card, adding roughly another 30 days to the float. But the p-card advantage goes far beyond the benefits of payment timing. Companies with strong programs receive regular infusions of cash in the form of rebates from the issuing bank. Ted Klein, formerly director of the corporate card program at General Motors Corp., recalls the fun he had handing his boss a large check from Citibank every quarter -- a very tangible sign of cash recycled back to the buyer. Rebates are a closely guarded secret, and Klein won't say how much GM received. But other sources indicate that 20 to 30 basis points is fairly common for a high-volume program, and rumors tell of rebates as high as 1 percent. While GM's rebate was more than enough to cover the salaries and benefits of the two professionals who ran the program, its impact on the automaker's bottom line was minimal, Klein admits. But the p-card program saved a big pile of cash by creating a more efficient purchasing process that enabled a reduction in head count. P-cards have been sold based on an ROI analysis that assumes "more productive use of corporate resources," says Pieroth. Those theoretical savings are "a little hard for most CFOs to swallow," he adds. "Until you actually reduce head count or negotiate lower prices, you don't see any hard-dollar savings." When a finance EVP badgered Klein into calculating the hard dollars GM actually saves from its MasterCard International program, he came up with $34.11 per transaction. At GM's transaction level, that amounts to $1.8 million a year -- real cash that strengthens the corporation's liquidity position instead of being burned as overhead. |
Liquid Gold: P-Cards Save Dollars, If Not FloatConverting indirect suppliers to purchasing-card payment may cost the buyer a little float, but the gain in liquidity -- from discounts and lower processing costs -- is many times greater. The hard-dollar savings are documented in a fourth-quarter 2002 survey of more than 50 large corporations in 12 industries commissioned by American Express, New York City, and conducted by Accenture. Among the highlights:
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