Today, the U.S. economy is robust by many metrics (gross domestic product, unemployment, corporate profits). And yet, U.S. businesses are holding onto a lot of cash. According to the Carfang Group’s analysis of the Federal Reserve’s Quarterly Flow of Funds Report, cash levels for U.S. corporations reached $4 trillion in 2023. Although that is $136 billion below pandemic highs, it is $1.25 trillion (or 45 percent) above their long-term trendline. My company, Berkshire Money Management, has holdings at a similarly elevated level.
Companies hold cash for various reasons. Whether due to geopolitical tensions, a divisive domestic election, or high inflation, many business owners and managers are holding onto cash because they remain cautious regarding their industries or the aggregate economy. Interestingly, anecdotal surveys of business owners and managers reveal confidence in their own company but concern about others. Nonetheless, concerns about industry colleagues and the broader economy may affect cash management decisions. Or businesses might be preparing for new opportunities.
At my company, we’re holding onto excess cash in our corporate account (which would normally be available to the two owners of this Subchapter-S corporation to pay off debts, invest in our retirement portfolios, and in other suitable ways) as we seek acquisitions of money management firms, insurance companies, accounting and legal practices, and other complementary businesses. The problem with that decision has been that acquisition opportunities remain unavailable and this cash strategy is feeling more hopeful than actionable. As with any strategy, its usefulness may have run its course. I am reevaluating my current cash management strategy and encourage my fellow owners and managers to join me.
Is your cash strategy out of date?
Sunny has been hoarding her cash because she is “waiting for the next shoe to drop.” She owns a landscaping company based in New Britain, Conn., specializing in golf courses. Although she does not have a marketing or sales team, the demand for her services has been growing. She has the capacity to maintain her four golf course clients and has a waitlist of three additional courses, but has been hesitant to invest her cash in new equipment and hiring additional employees. Despite the opportunity, Sunny is content using the waitlist as a defensive tool — she rests easier knowing that if she loses a client, she can replace them.
Sunny is an entrepreneur. By definition, she’s an optimist, a risk-taker, a mover and a shaker. Yet, Sunny is more comfortable hoarding cash at this time. Instead of increasing her sales by 75 percent and her profits by a similar amount (the margin would likely be a bit less due to a lack of scalability and fuel costs to reach the slightly more distant sites), she is taking a precautionary approach.
Sunny has been waiting for the next shoe to drop since mid-2022 when the Federal Reserve began its interest rate hiking campaign to fight inflation. At that time, seemingly every economic pundit, household, and business predicted a recession that never came. Perhaps it was prudent of her given the temperature of the economic calls of the time. But since then, inflation has come down, the economy has more than endured higher interest rates, and more and more people are visiting golf courses. What may have once been a prudent strategy — maintaining cash in anticipation of an economic slowdown — may now be outdated.
Sunny could ease out of her defensive strategy and take on one new client. That would allow her to maintain some of her cash holdings, keep her defensive waitlist and increase profits.
Playing it safe isn’t always the safe choice
At age 62, Brent isn’t ready to retire, but he is less interested in investing in his heating, ventilation and air conditioning company’s growth. Much of his company’s revenue comes from on-site visits for tune-ups, maintenance and duct cleaning in the Springfield, Mass., area. The increasing demand for residential HVAC services in the region would require more service trucks and employees. But Brent has so far opted out of participating in that growth.
Brent’s profit margin is a comfortable 8 percent, not far from the industry average. Instead of taking the investment risk and putting in the effort of capturing an 8 percent return on new investment, he parks his corporate cash in the Schwab Treasury Obligations Money Fund Ultra Shares, which yields more than 5 percent. Brent might give up the 3 percent difference, but he doesn’t have to take on the entrepreneurial risk.
Brent’s money fund holding is likely a smart short-term strategy for him. However, Brent should consider that not reinvesting in his company will decline its value and make it more challenging to sell at a premium price when he does decide to retire. Brent should consider taking on a minority partner to use their cash to invest in an expansion. Or, if Brent is comfortable with a 5 percent return, he could sell his company now and lock in similar rates in U.S. Treasuries or even corporate bonds that yield more.
When you boil it down, many owners and managers hold so much cash out of fear. Where I work, it’s been the fear of missing an opportunity. For others, the fear is more precautionary. But no matter the genesis, it may be time to review what we’re doing with our excessive cash holdings. For instance, floating rate debit or recently-initiated fixed debt probably has a high interest rate that could be paid off. If you’re concerned that you would no longer have access to capital, you can talk to your bank before the debt elimination to establish a revolving line of credit contingent upon reducing the current debt. Or the company could return the money to shareholders to invest it in a high-yielding money fund or the stock market.
It is common for the best companies to adapt to a changing world nimbly. Often, we consider those adaptations to be more seismic, such as evolving consumer preferences or a shifting addressable market. It is essential to recognize elements that may not typically receive as much consideration, like how you’re managing your cash.
This article first appeared in the Berkshire Eagle on May 11, 2024.