Everyone knows the importance of cash flow in motivating shareholder value optimization. But most of the corporate officials fail to give due importance to earnings per share. They do not give priority to cash flow optimization which ultimately short-changes shareholders.
However, any wise financial director understands today how vital is it to study cash flow trends before they borrow from a bank or invest in market.
What today dominates in this regard is emphasis on sales and earnings and cash flow optimization takes a back seat. Today’s dwindling market situations have led to huge depreciation in cash value. Very few shareholders now come back in case a company’s return on cash is low. Thus if any business firm returns cash to its shareholders instead of investing in various sectors, they regard it safer place to put their money.
A large amount of working capital, however, is likely to give negative return. Therefore, a wiser focus on cash flow and ways to optimize cash consumption and working capital will better push toward achieving best shareholder value.
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Most of corporate people fail to understand cash culture. Even if they understand, this understanding does not reflect in their management operations. A study by REL of around 800 giant European firms showed that most of them are not following ways to optimize cash flow.
There has been a continuous decrease in Cash conversion efficiency in last three years. This clearly expresses how firms have failed to convert their product into cash. In the study conducted by REL only 12 per cent companies were found improving their working capital and the rest failed.
Globally, such ignorance to cash flow optimization led to a direct reduction in Free Cash Flow [FCF] by 18 per cent per year. Debt on companies kept on accumulating by US$147 billion every year and 11 per cent of the total at the end of three years taken for consideration by the REL study.
It is strange why management is overlooking cash flow optimization and not giving it any priority despite knowing the fact that this can generate maximum shareholder value. Shareholders have no role in it yet it could be more profitable and justified if companies had showed a human face by giving value to those shareholders. Management seems to be suffering from short-sightedness ignoring the real importance of cash optimization.
Companies are also facing tough situation in managing their cash owing to continued volatility of markets and unprecedented increase in growth measures after economic depression. According to the Hackett Group’s 2013 Operating Cash Flow Forecasting Study, only 20 per cent firms are in a position to forecast their mid-term cash requirements. Market conditions are so volatile now that even these forecasts have lost importance due to their decreasing accuracy.
An in-depth look at functioning of top performers reflects that they have been focusing on a strong working capital which decreased risks of reduction in cash flows. They recognize the fact that giving value to cash flow sounds sexy, especially seeing the current scenario of high uncertainty. A good cash management and best possible forecast have lots of benefits. They result in good returns and better utilization of idle cash. This also reduces exposure to foreign exchange and creates chances to utilize supplier discount schemes.
A company’s success depends on each individual working in it and the role of management should be to optimize its every resource following the mantra of “Cash is King.”
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