According to the Bureau of Economic Analysis, corporations have witnessed immense gain since 1950, with profit growth of 36.8% in 2010. With the affirmation of growth in corporate profits, many have asked why more jobs have not been created despite rising corporate profits?
Claims that corporations are “sitting on” more than $1.93 trillion of cash, attempt to portray U.S CEOs as being wicked, since they are not using the cash to create jobs. However, there is more than that one figure that must be considered when examining the financial strength of corporations and the reasons they are unwilling to hire.
Starting off with one of the reasons for lack of corporate spending is obviously the low or uncertain customer demand. After the recession of 2008, only the federal government had strong spending while the other two pillars of economic demand; customer and company spending remained weak. This lack of customer demand adds to the risk the companies face, and makes them unwilling to invest further in their business. Another major reason is the unpredictability or uncertainty of taxes and regulatory policies. Withholding cash in times of uncertainty ensures high flexibility and liquidity. Hiring more employees and expanding in a situation of economic uncertainty, is a very big gamble which the many companies are unwilling to take after most going through a near-death experience of their businesses after the “great recession”.
Adrian Cronje, CIO at an Atlanta-based wealth management firm, stated that the U.S companies have record level of cash on their balance sheet which makes up for approximately 15% of the market capital but regardless of the fact, are still unwilling to hire, expand or invest. The truth is corporations are not nearly as healthy as the media often portrays them as.
Alan Reynolds wrote a superb op-ed in the WSJ, highlighting the myths regarding corporate cash and the undeniable ignorance of basic principles of accounting. According to him, there are four points that need to be kept in mind before jumping into conclusions regarding businesses’ financial health based on their balance sheet. The points are:
l There are two sides, assets and liabilities, in a balance sheet.
l Cash, a liquid asset, is used by companies as a safety cushion to minimize the impact of an unpredictable crisis.
l The balance sheet of the business is in no way the income statement
l Large corporations indulge in internal and external sources of funds in order to acquire real and financial capital and these internal and external sources are not mutually exclusive.
Determining the financial health of U.S corporations keeping in mind the above mentioned points gives a clear picture of the real financial strength of businesses. Reynolds states that from 2007 to 2010, the value of the real estate owned by U.S corporations went down by 30%, a $2.8 trillion loss. The only reason for the increase in the cash-to-total assets ratio was due to the decrease in the value of assets. Due to the decrease in the value of real estate and the increase in debt, the net worth of the company was $12.6 trillion in 2009, down from a $15.9 trillion in 2007. The example clearly depicts that the figures of the liquid assets on the balance sheet of the corporations mean nothing can only compensate so much for the loss in total assets.
The recession forced the corporations to increase short-term debt by a total of $3.67 trillion. Businesses clearly are still not healthy enough to consider expanding or investing as the $1.93 trillion of cash that they had unfairly “hoarded” does not even fully cover the existing short-term debt.
The pressure exerted on companies to start hiring based on the balance sheet figures makes little or no sense. It is the income statement which shows the income of the company based on which the companies decide to hire or expand (Although, it must be noted that corporate profits are at a record high currently).
The last point to consider is, internal and external sources of funds are not substitutes of each other. Just because a company is making use of profits (internal source) to increase funds, does not mean it is decreasing the use of debts (external source).
All the pundits should brush up on the basics of accounting and keep the points in mind, before jumping into conclusions regarding the financial health of the businesses based on their “cash hoard”.
Claims that corporations are “sitting on” more than $1.93 trillion of cash, attempt to portray U.S CEOs as being wicked, since they are not using the cash to create jobs. However, there is more than that one figure that must be considered when examining the financial strength of corporations and the reasons they are unwilling to hire.
Starting off with one of the reasons for lack of corporate spending is obviously the low or uncertain customer demand. After the recession of 2008, only the federal government had strong spending while the other two pillars of economic demand; customer and company spending remained weak. This lack of customer demand adds to the risk the companies face, and makes them unwilling to invest further in their business. Another major reason is the unpredictability or uncertainty of taxes and regulatory policies. Withholding cash in times of uncertainty ensures high flexibility and liquidity. Hiring more employees and expanding in a situation of economic uncertainty, is a very big gamble which the many companies are unwilling to take after most going through a near-death experience of their businesses after the “great recession”.
Adrian Cronje, CIO at an Atlanta-based wealth management firm, stated that the U.S companies have record level of cash on their balance sheet which makes up for approximately 15% of the market capital but regardless of the fact, are still unwilling to hire, expand or invest. The truth is corporations are not nearly as healthy as the media often portrays them as.
Alan Reynolds wrote a superb op-ed in the WSJ, highlighting the myths regarding corporate cash and the undeniable ignorance of basic principles of accounting. According to him, there are four points that need to be kept in mind before jumping into conclusions regarding businesses’ financial health based on their balance sheet. The points are:
l There are two sides, assets and liabilities, in a balance sheet.
l Cash, a liquid asset, is used by companies as a safety cushion to minimize the impact of an unpredictable crisis.
l The balance sheet of the business is in no way the income statement
l Large corporations indulge in internal and external sources of funds in order to acquire real and financial capital and these internal and external sources are not mutually exclusive.
Determining the financial health of U.S corporations keeping in mind the above mentioned points gives a clear picture of the real financial strength of businesses. Reynolds states that from 2007 to 2010, the value of the real estate owned by U.S corporations went down by 30%, a $2.8 trillion loss. The only reason for the increase in the cash-to-total assets ratio was due to the decrease in the value of assets. Due to the decrease in the value of real estate and the increase in debt, the net worth of the company was $12.6 trillion in 2009, down from a $15.9 trillion in 2007. The example clearly depicts that the figures of the liquid assets on the balance sheet of the corporations mean nothing can only compensate so much for the loss in total assets.
The recession forced the corporations to increase short-term debt by a total of $3.67 trillion. Businesses clearly are still not healthy enough to consider expanding or investing as the $1.93 trillion of cash that they had unfairly “hoarded” does not even fully cover the existing short-term debt.
The pressure exerted on companies to start hiring based on the balance sheet figures makes little or no sense. It is the income statement which shows the income of the company based on which the companies decide to hire or expand (Although, it must be noted that corporate profits are at a record high currently).
The last point to consider is, internal and external sources of funds are not substitutes of each other. Just because a company is making use of profits (internal source) to increase funds, does not mean it is decreasing the use of debts (external source).
All the pundits should brush up on the basics of accounting and keep the points in mind, before jumping into conclusions regarding the financial health of the businesses based on their “cash hoard”.
