What is restricted capital worth?
Part II of our analysis looks at the valuation process. Is a dollar in the bank equal to a
$1.00 on the balance sheet? After reading the cfo.com/cash-management article it is very rational to believe that value is indeed relative. It is imperative to know how the is cash going to be used when it is put to work. The chart below (data provided by CFO.com) illustrates the methodology; how the return on the dollar is dependent upon the company’s position and their investment targets or allocation strategy.
Permanently Reinvested Earnings (PRE)
Companies will spend cash in different ways depending on their positon in the growth spectrum, i.e. startup, early growth, mature growth, and aging decline. Some use cash to generate growth while others payout cash via retained earnings, as dividend payments. Cash is more valuable to companies with viable investment opportunities!
We know the world is full of low-margin companies struggling to produce a profit as are the companies with limited access to capital markets. These companies will not generate a high return on cash, due to the industry and their position in the corporate lifecycle. Financial markets reward promising startups by providing access to capital. Investors seek out these companies to generate higher returns on their investments.
Companies that typically do not produce a high return on cash are the established blue chip companies that pay dividends and have easy access to capital, companies paying off current debt, or companies with limited growth opportunities.
“Once a company is “producing capital” or generating more earnings than it can reinvest and earn profit, the value of a retained dollar quickly falls below par. For companies with the highest credit strength, as represented by having a commercial paper program, balance-sheet cash is worth less than half its face value.” (Hans Tallis)*
*CFO.comhttp://ww2.cfo.com/cash-management/2014/11/the-value-of-cash-do-not-post/by Hans Tallis, Contributor
"Value is indeed relative to the uses and parties involved in transactions, especially when it comes to financial reporting and Wall Street."
The Efficient Use of Capital
Would you agree that cash is a commodity? Did you notice a correlation between a companies use and the corresponding value of the cash? The value of cash appears to be dependent upon the use and the parties involved in the exchange. It is clear that companies with high research and development costs, high capital expenditures, and growth potential are the most efficient at using capital. The middle three companies are ones that raise private capital or have a well establish source of revenues from different sources (diversified income), and those that raise capital in public markets.
Then there are companies that are net distributers of capital thru dividend payouts or they are in a low growth phase, and then there are companies that rely on the commercial paper markets for funding. Regardless of the phase or potential of these companies, the authors established a value-oriented analysis of $1 for companies and their shareholders.
Where is the Value?
We have just discovered the numbers on a financial statement can be quite deceptive and misleading. The risk of relying on misleading information still exists in spite of new regulations and oversight of the financial markets. This scenario is very disturbing and challenges the enforcement of reporting standards. So it appears, a dollar is not always equal to a $1.00. Value is relative to the uses and the parties involved in transactions, especially when it comes to financial reporting and Wall Street.
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Cash flow Statements: Operating, Investing, and Financing -
Revenue or Other Comprehensive Income?
