Strategic Corporate Finance: Applications in Valuation and Capital Structure

HOW MUCH IS TOO MUCH?

Corporate cash and cash equivalents is a large and growing number on most balance sheets today. But many analysts are now suggesting that this is a large and unmanaged number. Only recently have we seen such interest in determining the right level of cash. The search for optimal capital structure has been expanded to include assets, such as cash and marketable securities and corporate pension assets.

Cash balances vary widely. Domestic cash balances of U.S.-listed companies range from $3 million at the 10th percentile to $930 million at the 90th percentile, with a mean of $691 million. Even after adjusting for variation in company size, cash ranged from about 1 percent of revenue at the 10th percentile, to 143 percent at the 90th percentile. On an industry sector basis, the largest cash to sales positions are in healthcare (724 percent), technology (73 percent), and media (48 percent). We obtain similar insights with other size criteria, such as cash as percentage of assets or enterprise value.

To manage cash balances better as part of the optimal capital structure solution, companies have started employing methods to determine acceptable, if not optimal, cash balances, that is, cash positions within industry norms. Typical approaches involve industry benchmarking and rules of thumb plus whatever guidance is made available by ratings agencies and analysts. We refine both of these approaches, adding multivariate regression and simulation-based liquidity models ...