Food for Treasury Thought: A Recipe to Set Minimum Cash Levels

One high-growth tech treasurer shares the multiple ingredients he uses to cook up a cash level that hits the spot.
 
Every corporate treasurer needs to have a point of view about the level of cash their company should keep on hand.  Too much and activist investors may begin targeting the company’s stock. But wind up with too little to weather an emergency and the treasurer could be looking for a new job.  

• Members of NeuGroup for Growth-Tech Treasurers tackled this question at a recent meeting, including some discussion of simple rules of thumb, like having the cash equivalent of three months to a year of forecasted operating expenses; or holding cash equal to a small percentage of the company’s market capitalization.
• But in the end, the group consensus was that there is no one formula that can be applied across the board because companies and their industries are too different. 
• Luckily, though, the presentation of one corporate treasurer provided a basic “recipe” that can be applied to help determine the appropriate minimum cash level for a company’s specific circumstances—regardless of size or industry.

The cash level cookbook. The recipe has four main ingredients: 

1. Liquidity considerations. These encompass a company’s cash conversion cycle, working capital and operating expenses, including estimates for seasonality and growth prospects. 
   1. Next are the company’s business profile, especially its net margins and top line growth prospects, followed by its financial profile, including commitments to stakeholders. 
   2. Carefully consider financial policies, a company’s preferred credit rating and its policies on leverage, dividends and share repurchases. 
   3. Making a cold-blooded analysis of access to funding is critical, as financial flexibility increases with credit quality.  Finally, company strategy is important.  A serial acquirer must always have ample cash and financing available, as do companies that can be subject to high levels of business volatility. 
2. The market’s key liquidity metrics and indicators. Among the many used by market analysts, the key ones include cash to market capitalization; cash to revenue; liquidity ratios such as cash to debt, current ratio, quick ratio, and acid ratio; the cash conversion cycle, which is the days inventory outstanding plus days sales outstanding minus the days payables outstanding. 
   1. From an accounting perspective, these metrics and indicators are snapshots in time, historical facts. But it is also important to agree on a range that these might achieve in the future based on business successes, failures, and external events.
3. Peer group analysis. This is an extremely useful process because it can engender a stimulating discussion every time a company in the peer group strays far above or below the average for each of the liquidity metrics and indicators. 
   1. It is also part of an essential feedback loop, as observations about what peers are doing can be factored back into financial policies
4. A subjective review of the results by treasury and the executive management team.  This final ingredient is crucial to having the target levels endorsed and turned into policy. 
   1. After that, periodic reviews can help refine and update the policy, allowing everyone in management to sleep soundly, knowing the company has sufficient access to cash to withstand any shocks that appear.

Defining cash. Finally, treasury and management must agree on the definition of “cash.” This group was unanimous in choosing to include cash and highly liquid securities in the basic definition, with other sources of liquidity (such as committed term bank facilities) to be added later in the process, if warranted.  

• Also, most members agreed that stress testing can be done at every stage of the process, but that it is probably most valuable when done at the end, after the peer group analysis and during the management review.