Introduction to Corporate Finance

19: Cash, Payables and Liquidity Management

HOW COMPANIES DETERMINE THE AMOUNT OF EXCESS CASH TO HOLD

Financial researchers have developed a clear picture of the working capital practices of US companies

and, to a lesser extent, Australian companies. Less is known about how companies headquartered in other

major countries manage their liquidity needs. An international 2010 survey, the most recent available,

enriches our understanding of the factors that have an impact on how much cash and marketable securities

international companies hold. Professors Karl Lins, Henri Servaes and Peter Tufano surveyed companies

in 29 countries, and the results highlight two important points. First, they suggest that international

companies pursue liquidity management policies that are generally similar to those followed by US

companies. Second, they reveal that corporations everywhere make an important distinction between

cash and marketable securities held for operational purposes versus cash and liquid assets held for non-

operational and safety reasons.

The following table summarises managerial responses about cash holdings. It describes the

importance of various factors in determining how much excess cash – defined as holdings of cash and

marketable securities in excess of operating needs – managers choose to hold. For the full sample

of companies, total cash holdings amount to 9% of the book value of assets, but cash held for non-

operational purposes amounts to only 40% of total cash holdings. The most important reason managers

give for holding excess cash is to serve as a buffer for possible future cash flow shortfalls, while the need

to maintain adequate cash to ensure efficient running of the company is the second-most frequently

mentioned reason. Managers are also concerned about ensuring the cost and potential availability of

funds in case the company needs to obtain working capital quickly or during an emergency.

SURVEY RESPONSES TO QUESTIONS ABOUT NON-OPERATIONAL CASH

‘In deciding how much excess cash to hold, how important are the following factors?’

Factor Percentage responding ‘important’ or ‘very important’

Cash as a buffer against future cash flow shortfalls 47

Minimal cash ensures efficient running of the company 35

Difference between interest rate on cash and interest rate on debt 35

Time it takes to raise money when funds are needed 31

Level of uncertainty about future investment opportunities 31

Ability to issue debt at a ‘fair’ price when funds are needed 30

Difference between interest rate on cash and cost of capital 26

Size of the undrawn credit facility 23

Transactions costs of raising funds 22

finance in practice

Source: Reprinted from Karl V Lins, Henri Servaes and Peter Tufano, ‘What Drives Corporate Liquidity? An International Survey of Cash Holdings and Lines of Credit,’ Journal of

Financial Economics, Volume 98, 1 October 2010, pp. 160–76. With permission from Elsevier.

A bank account analysis statement is a report (usually monthly) provided to a bank’s commercial

customers that specifies all services provided, including items processed and any charges assessed. It is

basically a detailed invoice that lists all cheques cleared, account charges, lockbox charges, electronic

transactions, and so on. The statement also lists all balances held by the company at the bank, and

includes a computation of the credit earned by the company on those balances. Most companies on

bank account analysis

statement

A regular report (usually

monthly) provided to a bank’s

commercial customers that

specifies all services provided,

including items processed and

any charges assessed