When Cash is King

By James Gentry
April 15, 2009 05:51 PM

As more companies have fallen into dire financial straits in recent months, the old cliché, “cash is king,” seems to appear ever more frequently.

And if cash is indeed king, that raises a series of questions. What is it? When is it enough? How can a company get more?

To frame these questions, let’s examine General Motors’ 10-Q for cash problems. Because of plunging auto sales and an outdated cost structure, the company has been losing money for some time. Especially interesting for reporters is the fact that in every quarter since Dec. 31, 2007, GM’s cash and cash equivalents have declined.

This steady decline in cash and cash equivalents allows reporters to calculate the “burn rate,” which is the rate at which the company will run out of cash if the trend continues. For GM, its cash and cash equivalents declined by $3.2 billion from Dec. 31, 2007 to March 31, 2008, the end of the next quarter. A reporter can divide $3.2 billion into the March 31 figure of $21.6 billion to project that GM would be out of cash in 6.7 quarters IF the burn rate remained at $3.2 billion.

And that is a big IF. For GM, it’s unlikely since the government has decided the company can’t be allowed to fail.

This technique should sound familiar to veteran reporters since such projections were commonplace back in the 1980s as observers frequently, and with a high degree of accuracy, predicted when savings and loans would be insolvent.

Gary Trennepohl, a finance professor who frequently works with business reporters, said the best measure is actually the daily cash burn number. He said it is important to ask: “Is the company reducing its cash balances each day and by how much? How many days can they last at that rate?”

Since reporters can’t get access to the daily rate, the 10-Q becomes the best source since it shows cash and cash equivalents at the end of each quarter.

Trennepohl, the president of Oklahoma State University-Tulsa, said the next best indicator is access to liquidity, which brings us to the first question on our list.

What is cash?
A good starting point is “cash and cash equivalents,” which is found on both the statement of cash flows and the balance sheet. Typically, cash equivalents are defined as instruments that are so safe and liquid that they can be considered as good as cash. Examples are short-term Treasury bills and commercial paper.

Trennepohl’s comment about access to liquidity means that the amount of cash a company needs will be reduced if a company has reasonably easy access to credit.

What’s enough?
To get a feel for how much cash is enough, a reporter can examine at least two measures. First, is the company generating positive cash flow? To answer this question, simply look at the statement of cash flows and see if the “cash and cash equivalents” category is increasing from quarter to quarter. And to see if the category “cash from operations” is increasing as well.

Second, some analysts advocate using a variety of ratios. In their article in the Journal of Accountancy entitled “The Power of Cash Flow Ratios,” authors John R. Mills and Jeanne H. Yamaura make the case for two types of ratios: “ratios that test for solvency and liquidity, and those that indicate the viability of a company as a going concern.” To learn more about how to use these ratios, see:
http://www.journalofaccountancy.com/Issues/1998/Oct/mills.htm

Finding more green
With many companies feeling a cash squeeze, they are busy looking for ways to ease the pain. Some of the most common ways companies are creating more liquidity include reducing spending with suppliers, reducing travel and entertainment costs, managing inventory more closely and doing a better job of collecting accounts receivable.

In addition, companies are looking at ways to defer income and accelerate deductions in an effort to manage taxes.

Reporters should be especially alert for companies cutting capital expenditures as a way to preserve cash since the failure to modernize plants and equipment can jeopardize future growth. To learn if a company is cutting “capex,” read the Management Discussion and Analysis section of the 10-K and look at the section of the statement of cash flows entitled “Cash flows from investing activities” to determine if categories such as “capital expenditures” or “purchases of property and equipment” are decreasing from the previous year.

One final point: Why are cash numbers so important? The answer is simple: Most finance experts consider cash numbers to be far more difficult to massage than net income, which can be maneuvered by using perfectly legal accounting rules.

When times are uncertain, analysts, experts and journalists are looking for numbers they can depend on. Cash provides some certainty.

James K. Gentry is a professor at the William Allen White School of Journalism and Mass Communication at the University of Kansas.

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Copyright © 2009 Donald W. Reynolds National Center for Business Journalism