Cash replaces inventories and receivables on corporate balance sheets

Canada’s corporations have indeed increased the amount of cash on their balance sheets but it is a survival strategy, not an avoidance strategy, says the C.D. Howe Institute.

In a recent report entitled “Not Dead Yet: The Changing Role of Cash on Corporate Balance Sheets,” Finn Poschmann, C. D. Howe’s vice president of research, examines the growing amount of cash on corporate balance sheets and concludes it is not the result of a failure of businesses to invest. Rather, it is attributable in good part to economic conditions and businesses’ need to keep their assets liquid.

“Businesses appear to have been responding to long-term trends in economic conditions,” writes Poschmann, “by better managing their balance sheets."

“Concern over mounting corporate cash seems mistaken,” he adds. “While businesses have increased the share of assets they hold as cash, improving their resilience through the business cycle, they have simultaneously decreased their share of current assets held in non-income-earning forms, such as inventories and accounts receivable.”

Poschmann looks at changes in the inventory-to-shipments ratio and finds it has decreased steadily for Canadian manufacturers since the mid-1980s when the average ratio for the previous 30 years had been 175%. Since the 1990s, the ratio has averaged 140%.

There are a number of reasons for this, Poschman explains, all of which indicate increased efficiency:

• the “shipping container revolution” which lowered costs and improved delivery enabling businesses to carry less inventory;
• free trade agreements which increased competition at the same time as it integrated cross-border manufacturing;
• the spread of just-in-time manufacturing processes;
• the advent of management-information systems. “The success, growth and spread of Wal-Mart, which increased the integration of information flows among suppliers, shippers and distributors, also changed the competitive environment,” Poschmann says.
• the need to be liquid to cover operating costs when economic conditions demand it.

Poschmann also notes that over the past 25 years, in domestic non-financial corporations, inventories have fallen to 8% from almost 15% of assets; accounts receivable to 11% from 14%, and cash has risen to slightly less than 8% from 4% of assets.

The manufacturing subsector lead the way. Just-in-time delivery and improved trade logistics allowed inventories to fall to 9% from 17% of assets, improved reporting systems took accounts receivable to 9% from more than 16%, while cash rose to almost 6% from 3%.

Even the retail sector shared in the gains. There, inventories fell to less than 30% from more than 40%; accounts receivable went to 9% from 10%, while cash rose to 9% from 5%.

Indeed, rather than a concern requiring a public policy response, Poschman maintains the “liveliness” of corporate balance sheets has improved, not “atrophied.”

“In the absence of an apparent business or market failure,” he concludes,  “no policy concern, or response, is indicated.”