Organizational liquidity management holds great importance in the list of priorities for corporate treasurers. Capital raising requirements are constantly tightening while companies are looking to decrease their cost of capital when conducting business. In this type of environment, while low-liquidity companies certainly have their own set of challenges to contend with, there are challenges, albeit of a lower-gravity nature for companies that are liquidity-rich as well. With higher banking regulations and negative rate offerings, the traditional channels that treasuries could lock their money in to earn a steady return are not as readily available. This has consequently caused these treasuries to search for yield elsewhere.
To use excess liquidity optimally, corporates have a variety of options to deploy capital efficiently. The first one is to conduct accretive mergers and acquisitions (M&A) that provide stronger EPS to shareholders. The rationale for conducting an M&A is most often to benefit from operational, strategic and financial synergies that the combined company can offer to shareholders. Managers and owners of businesses that have excess cash on their balance sheets scope out other businesses that complement their own long term strategy and/or offer efficiencies that can reduce per unit costs of the product they manufacture/service.
The idea here is to create a scenario where per share earnings are enhanced. This done either through revenue expansion, through cost reduction and in many cases, both. Companies that have a large amount of excess cash are most likely to use this strategy to “buy” growth and market share in the existing industry or a new industry.
Capital Expenditure Channels
Another deployment of cash can be used in capital expenditure channels where companies make additions to property, plant and/or equipment that is used in the business. This capital expenditure can be thought of as an individual project. Just like projects are valued as a sum of their cash inflows and outflows to arrive at a net present value, capital expenditure is an initial outflow that is used to buy inflow-generating vehicles. The idea is to ensure that these capital expenditures undertaken are used to buy factors that contribute to inflows over and above the 0 NPV threshold.
In that way, they differ from the regular operating expenditures reported on the income statement. Operating expenditures are undertaken by every company as a cost of doing business. These expenditures include marketing, SG&A, depreciation etc. Capital expenditures on the other hand are those undertaken that drive future benefits. It is for this reason that they are a preferred outlet for treasurers when undertaking liquidity management exercises to gain yields on excess cash.
Other Liquidity Management Tools
Some other excess liquidity management tools include the issuing of dividends that ensure owners of the business receive the excess cash in the business. This can be done through either regular announced dividends on a fixed schedule (quarterly or yearly) or through a special dividend where one-time excess cash can be redistributed to shareholders. However, another common way that treasurers have looked to deploy capital, particularly in research-intensive industries such as pharmaceuticals and biotech is through the use of research and development (R&D).
The R&D initiatives undertaken by companies serve a similar function as the capital expenditures mentioned earlier. A capital outflow at Time 0 in R&D can yield enhanced products, new innovations and/or other strategies to drive top line and bottom line growth – all of which are good news to existing and prospective shareholders.
It is clear that liquidity management is an important cog in a business wheel, whether it’s to manage low liquidity or optimize high liquidity. While low liquidity is detrimental to a business’s operational and capital prospects, scenarios of high liquidity can pose their own set of problems with the shrinking number of traditional channels. However, treasurers can and should choose to adopt alternative options to deploy capital and ensure that it earns a yield that complements the operational performance rather than just sit on the balance sheet, earning a minimum yield.