Why Cash Hoarding is Not a Sound Strategy

On the surface, saving money for a long period of economic rainy days makes sense. That is why companies are doing so in record numbers. Last year, businesses in the US were saving cash at unprecedented levels, with balances climbing to US$1.9 trillion, a 36% increase since Q109. It appears this trend will continue in Asia as well, as large companies sell corporate bonds in an effort to increase their cash holdings.

There is a problem with this strategy, however, and it is that it doesn’t give investors a return. Companies understandably want to hold cash as a hedge, but investors are concerned that cash is not being put to work earning a reasonable return. And when it comes to profitable, secure, short-term investment vehicles, there aren’t many options currently available.

Typically, companies might invest in money market mutual funds (MMMFs), interest-bearing deposits, treasuries, and so forth. But such investments have been earning the benchmark rate minus some spread of late. Last August, return rates in the US hovered around 0.25%, with no end in sight for these poor returns given the Fed’s recent comments about not raising the benchmark Fed Funds rate significantly until sometime in 2013.

Companies looking to maximise their returns on otherwise idle cash would do better by thinking in terms of the value that cash can create. Cash that’s hoarded in traditional, low-return liquidity vehicles is cash that’s not just losing value, it’s potentially creating risk.

As the gap between low-quality and high-quality borrowers grows, more suppliers will experience cash flow problems. And many will ultimately fail, creating disruptions in the supply chain that can negatively impact operations. Buyers with cash on hand can head off such problems by investing their stash in their supply chain.

Every company has an interconnected web of buyers and suppliers. Smart companies can use the transactions they make on a daily basis with their suppliers to their advantage.

Here’s how it works: in return for a discount, you can accelerate payments for approved invoices to key suppliers. You earn an immediate return on your cash. And your trading partners can use that cash to fund their daily business needs and ensure they can meet your ongoing supply demands.

The process is known as dynamic discounting and it is gaining popularity. On the Ariba network, an online supply network used by more than 730,000 buyers and sellers, over US$4.5m in discounts have been captured in the past year. Buyers receiving these discounts saw average annual returns of anywhere between 10% and 36%.

Getting buyers to agree to pay early and sellers to offer a discount might seem like an impossible task. But new technologies actually make it possible. Delivered in the cloud, such solutions provide buyers and sellers with all of the tools necessary to fully automate the process of offering, negotiating, and agreeing on early payment terms. Buyers can capture discounts at any point between invoice approval and the net due date and automatically present offers to lock them in. Suppliers can automatically accept offers or control the acceleration of payment on an ad-hoc basis according to their needs.

During tight times, the tendency for most organisations is to shore up costs and adopt a myopic approach to conducting business. This is not the way to prepare for, or pull through, a market slow down.

As the perception of recession looms large over today’s economy, it is more important than ever for buyers and suppliers to work more closely together, share the economic burden of the times, and embrace innovative ways to ensure their mutual health. The supply base offers short-term investments with higher returns that carry very low risk. Companies bold enough to embrace such a creative approach can successfully navigate today’s rough waters and sail smoothly through any gathering economic storms.

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