Should Business Splash Its Cash?

Published in Investing on 16 April 2012

Big companies have over £750 billion in cash that they should be investing to spur growth.

According to official forecaster the Office for Budget Responsibility (OBR), the UK economy will grow by 0.8% in 2012. Not so, claim economists from the Ernst & Young ITEM Club, who expect our national output to rise by a mere 0.4% this year.

Stashing cash

One reason for the ITEM Club's pessimism is that British businesses are hoarding cash instead of using it to expand their operations, innovate and launch new products. Thus, while the ITEM Club expects the UK to avoid a double-dip recession (thanks to weak growth of between 0.1% and 0.2% between January and March), it remains gloomy on Britain's economic outlook as a whole.

Hence, the ITEM Club has urged corporate Britain to dip into its huge cash reserves -- estimated at £754 billion for private non-financial companies -- to invest, kick-start growth and prevent a 'dismal' 2012. Without this boost to investment, the ITEM Club expects growth of 1.5% next year, rising to 2.6% in 2014, again below OBR estimates.

Looking ahead, the ITEM Club expects UK unemployment to peak next year at close to three million, which implies another 330,000 job losses. The unemployment rate will peak at 9.3% of the workforce, before easing back.

Peter Spencer, chief economic adviser to the Ernst & Young ITEM Club, today warned, "Business investment has picked up nicely in the US, but UK companies remain extremely risk-averse, which is sapping strength from the economy...The business community needs to grasp this opportunity quickly, or face the consequences after the next General Election."

Splashing cash

To put this cash pile into context, £754 billion is around half our current GDP (Gross Domestic Product, or national output). Were even a fifth of this sum -- £150 billion or more -- to be invested here in the UK, it would provide a much-needed shot in the arm to our limping economy.

Now for the bad news: this figure shows only the cash on company balance sheets and ignores company debts. In other words, it is not a measure of the net cash businesses have, only the liquidity they enjoy today.

In fact, it is highly unusual for large corporations to have a net cash balance on their books. One British example is 'big pharma' firm and FTSE 100 stalwart AstraZeneca (LSE: AZN), which has net cash of $1.7 billion (£1.1 billion) and rising. Across the Atlantic, tech Goliath Apple (NASDAQ: APPL.US) has cash exceeding $100 billion, with this mountain growing by the day.

Hence, were British businesses to start splashing their cash, their liquidity would soon fall. This would increase their leverage (gearing) and thus make them riskier investments. Given the weakness of the UK economy, I'm sure that levering up to grow is not necessarily the right move for every firm.

A cash-starved economy

Then again, to see the stagnation caused by corporate cash-stashing, you only need look eastwards towards Japan.

After the economic devastation of the early Nineties, Japanese companies concentrated on rebuilding their shattered balance sheets and hoarding cash. Today, businesses in the Land of the Rising Sun have trillions of yen on their books. Alas, this stockpiling has stifled the Japanese economy, producing umpteen years of no or low growth.

In my view, this is a fine line for companies to tread. Those that invest -- in jobs, acquisitions, marketing and raising output -- will gain a competitive advantage over their rivals. On the other hand, those who splash their cash too freely could suffer abrupt declines if the world economy weakens further.

Alas, with non-financial companies increasing their cash holdings by £48 billion in 2010 and a further £82 billion last year, there is no sign yet of any corporate appetite to loosen the purse strings, start spending and prime the pump of recovery!

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blackwhite 16 Apr 2012 , 6:34pm

It would be interesting to also know how much 'cash' financial organisations are hoarding? I know it will be tricky and for some a paper exercise, ut given it is such a large percentage of UK's GDP, why not?

UncleEbenezer 16 Apr 2012 , 8:35pm

It's the zombie economy that inevitably follows a credit boom. Companies would rather hoard than invest in new things for which there will be no demand due to $world+dog having already spent their future.

Having said that, my VCT portfolio has seen some very profitable recent exits, as at least some bigger companies spend those cash piles on buying up smaller, innovative ones. Long may that continue!

snoekie 17 Apr 2012 , 11:15pm

Now if they pay down their debts, there is a margin to borrow later and save between 6-8% interest on borrowings, and have something for distressed synergistic acquisitions.

Now that would be smart thinking, but perhaps too clever for these overpaid directors,

fedupwithbanks 18 Apr 2012 , 10:18am

And this government is encouraging smaller businesses to invest their money by.....................................REDUCING capital allowances as from April 2012 from £100K per annum to £25K????????????!!!!!!!!!!!!!!!!

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