Corporate Cash - Fact or Fiction

Many examinations of corporate behavior during the credit crisis and subsequent recovery have focused on one issue - are companies sitting on a pile of cash?  Many pundits are now questioning the accuracy of this analysis.  We've previously blogged on the topic of what companies are currently using their capital for, and the fact that rather than investing in fixed goods or giving employees a raise (also covered in this blog) they have largely held onto their earnings.  This idea is included in the latest Economic Report of the President, for example, but seems to be gathering detractors.

The latest round of doubt comes from the high-profile website FiveThirtyEight.  In the first post in the Economics section, former Wall Street Journal reporter Ben Casselman argues that the current narrative of companies stockpiling cash is false.  He does not offer much in the way of quantitative support, something which against the ethos of FiveThirtyEight, but his argument is worth examining anyway. 

Casselman's argument is based on a data revision that the Federal Reserve made back in 2012, removing nearly half a trillion dollars from its estimate of liquid assets held by non-financial corporations.  In fact, Casselman wrote about the revision for the WSJ in 2012, reaching the same conclusion he reached in 2014.  But even though there is less cash than previously imagined, a vast amount of cash is still being collected. 

In his original analysis in 2012, Casselman pointed to the fact that there had not been a sharp uptick in the percentage of liquid assets held by non-financial corporations as a percentage of their total assets.  This is a measure of how much 'cash-like' securities corporations are holding, relative to the remainder of their assets.  I've reproduced the same metric in the chart below, but have added the far more illustrative liquid assets as a percentage of short-term liabilities.  The red line gives you an idea of how much of its short-term liabilities each company is carrying in liquid assets-- this can be a test of solvency-- and as you can see it has been steadily rising since 2000, minus a drop during the credit crunch when cash was scarce. Companies will normally seek to minimize the amount of cash they carry, as the returns are low compared to other investments (either in other financial assets, or in the business of the company itself).  Some cash must be carried on hand to deal with the normal course of operating the business, measured by short-term liabilities.  Cash holdings above the historical average level  of the ratio indicate cash that is being held but not required in the normal course of business (unless the business has changed dramatically).

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We’ll work our way back to cash, but first let’s ask a different question: are corporations currently profitable?  We've produced this chart before, showing corporate profits as a percentage of GDP, and the answer is most certainly yes.

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Indeed, most broad industry classifications have been more profitable in the last ten years than they have ever been, with the exception of manufacturing and transportation (see chart below). 

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Just because corporations are increasingly profitable does not mean that they are stockpiling cash; we have to dig further in order to determine where the money is going.  There are three possible outlets for corporate profits: retained earnings, taxes and dividends.  The chart below shows the total dollar value of corporate profits (dashed purple line - right hand axis), as well as where that money is going.  The percentage going to taxes has been declining steadily (blue line), while dividends and undistributed profits (red and green lines) are roughly inverse to one another.

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Obviously, the distinction can be made between cash that a company decides to give out to investors and cash that a company keeps, but no one would argue with the fact that it comes from a large cash stockpile either way.  The undistributed profits, or retained earnings, can either be saved or invested.  Again, the mere fact that earnings from corporate profits are high does not mean that companies are generating large amounts of cash.  They could be investing it instead. 

In fact, corporate investment (measured by private non-residential fixed investment) has been falling, even as corporate profits have been rising (see chart below).

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Private, non-residential fixed investment includes spending on equipment, IT, buildings, and intellectual property (like research and development).  While there has been a recent return to investment, retained earnings are being diverted more towards savings than they are towards investment.

Those savings can take the form of cash or other assets (stocks, bonds, etc.).  Coming up with a figure that represents the amount of cash on hand at a company can be difficult, since accounting practices can differ dramatically from company to company.  Net cash flow to companies is created by taking retained earnings and adding back in depreciation, since it is a non-cash expense.  This gives us an idea, beyond the accounting figures, of how much free cash a company has at its disposal, and it is a figure that has been steadily rising (see chart below).  

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If we adjust that flow of available cash and scale it to GDP for comparative purposes, as we have done on the preceding charts, it perfectly illustrates that cash coming out of the credit crisis and through the recovery has been steadily increasing (see chart below).  This is exactly the narrative that Casselman has labeled inaccurate, though he does not present much analysis to support that conclusion.

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Giving Casselman the benefit of the doubt, based on data from the Federal Reserve, it is still debatable as to whether the pools of 'corporate cash' are actually in cash-like instruments (liquid assets) or other investable assets.  But even with that interpretation, it is still hard to imagine that the entire narrative surrounding corporate wealth is wrong.  The money is there; it's simply a matter of what form that money has taken. 

Notes: All data from the Bureau of Economic Analysis, except the first chart which uses data from the Federal Reserve.