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Accounting Gimmicks Have Boosted The Collective S&P 500 Cash Balance By Over $150 Billion Since The Start Of The Crisis

Tyler Durden's picture





 

Much has been said lately about the record cash balance on the books of S&P 500 companies (ex. financials- those are a different story altogether). Bullish pundits claim that this money will be used for all sorts of M&A, stock buybacks, expansions, etc., to make the point that companies can't wait to go out spending, so we should all front run them and buy whatever public companies may one day be on the auction block. We decided to take the inverse approach - by looking at the balance sheet and the cash flow statement of the S&P 500 companies (again, ex fins), we have attempted to understand just what the source of all this excess cash is. Listening to any of the permabulls on CNBC, one could easily get the impression that all this newly record cash comes simply from excess revenue which, courtesy of massive layoffs and a collapsing SG&A line, feeds an ever increasing retained earnings line, which in turn goes straight to cash. While this is certainly possible, our analysis indicates that the primary source of cash over the past year has really been a very generous cash "rotating" adjustment in some critical CapEx and Net Working Capital items. Our findings demonstrate that of the nearly $130 billion in additional cash on the books of S&P 500 companies from June 2008, through September 2009, two key sources, net working capital and a reduced capex spend, have generated over $150 billion, meaning organic operations have accounted for a whopping -$20 billion (yes, negative) of incremental cash.

We have used CapitalIQ data to analyze quarterly periods beginning in December 31, 2005 through September 30, 2009 (the data for the most recent quarter has not been fully compiled yet, with about 100 companies having yet to file a 10-Q. Once all the required data has been deposited into Edgar, we will update this analysis for data including the Q4 2009 period).

First, we present the cash holdings for all companies, ex. fins, that make up the S&P 500. It should come as no surprise to anyone that companies have been hoarding cash: whether this is due to uncertainties about the future, or some other reason, is irrelevant. Again, our focus here is whether this cash was accumulated fair and square, or whether it was some simple accounting fudge of balance sheet/cash flow items.

So once we know that S&P500 balance sheets are replete with cash, the next question is not where it is going, but where did it come from. In other words, is this merely a transfer from one asset/liability to another?

We analyzed the Capital Expenditures and Depreciation and Amortization data of the universe under observation. What we noticed was a dramatic reduction in cash outflow patterns, coupled with a substantial increase in the depreciation and amortization, beginning with the Q1 2009 quarter, or just after the economy went to hell in H2 2008. As the chart below demonstrates, CapEx which has historically trended not only higher, but represented an average $26 billion differential to Depreciation and Amortization over the past 4 years, took a sudden and dramatic leg down beginning in Q1 2009. At precisely the same time companies, no doubt in order to get the benefit of a D&A tax shield, ramped up their asset depreciation activities. The net result: for the first time in many years, the differential between CapEx and D&A turned negative: companies were depreciating more than they were adding to their PP&E, in Q1, Q2 and Q3 (although in Q3 the number turned just slightly positive). This is the definition of asset stagnation, as normal asset-intensive businesses (remember, this exercise excludes financial companies), need to add to their PP&E by more than they traditionally depreciate due to the unequal GAAP amortization schedules. In other words, in the first three quarters of 2009, the S&P 500 asset base depreciated by much more than it was repleted, thus substantially impairing its cash-generative powers. This can be seen on the chart below.

It is no wonder then that companies managed to "generate" substantial cash - instead of investing in their asset base, they simply let PP&E (unadjusted for various GAAP gimmicks) decline, while building the cash and cash equivalents portion of the balance sheet.

What will be the impact of this going forward as the PP&E has to be renormalized? In the LTM period CapEx - D&A was negative $42 billion, while the average LTM differential over the past 4 years has been positive $13 billion. This means that companies will have to spend an incremental $55 billion over time just to catch up to the PP&E trendline, let alone to add incremental cash generating assets. And since the immediate IRR for organic capex is traditionally much higher than for external acquisitions (with some notable exceptions), it is only after this catch-up has been accomplished, that the S&P500 companies will be truly seeking M&A opportunities, as opposed to what the mainstream media will have you believe. The topic of how much less in taxes S&P 500 companies paid in 2009 due to the tax shield nature of the incremental D&A boost is a topic for another day.

In addition to cash retention through asset deterioration, another favorite trick of company CFOs is to boost cash at the expense of Net Working Capital (ex. cash), i.e. the difference between current assets (Accounts Receivable and Inventory) and current liabilities (Accounts Payable). Therefore, the next analysis we did was to analyze the Net Working Capital status of S&P 500 members. The results were as expected: from a peak of $520 billion in June of 2008, NWC (ex. cash) has declined to the current almost three year low of $430 billion. In other words, as companies have accelerated their cash collections via declining AR balances, they have also pursued inventory liquidations, coupled with flat or expanding Accounts Payables. The chart below shows this accounting gimmick in vivid color:

Following the cash generated by this decline in NWC, leads to the following chart: as pointed out above, roughly $90 billion has been generated simply as a function of squeezing cash out of other current net working capital, and simply rotating this into the cash & cash equivalents balance sheet item.

So what does combining all this data conclude? As was pointed out initially, the non-financial S&P500 companies boosted their cash holdings by roughly $130 billion from June 30, 2008 through September 30, 2009. This would have been great if this was cash attained in the traditional way, whereby sales get converted into retained earnings, and cash, all else equal. However, a dig through several hundred balance sheets and cash flow statements, indicates that of this $130 billion cash increase, about $90 billion was due to Net Working Capital Changes, and another $55 billion was due simply to underfunding capex by an amount required to preserve maintenance cash generation from existing asset bases. Which means that of the cash boost, operations generated a whopping...($15) billion in cash! Had companies not been using accounting gimmicks to boost cash on a one time basis, current cash would likely have been about $15 billion lower than June 30, 2008, or $688 billion. The adjusted cash balance, normalizing for Net Working Capital shifts and normalizing CapEx spending since June 30, 2008 is shown below:

The conclusion is that one should be very wary of generalizations such as those by JP Morgan which claim that companies, sitting on huge cash war chests, are now ready to go out and spend, spend, spend. The truth is that had companies not been using various accounting fudge factors, their real cash position would have been much more precarious. Should companies revert to their mean Net Working Capital and CapEx exposure over the past 4 years, we will see $155 billion of cash disappear merely to plug the hole that was dug over the past 3 quarters merely to make S&P 500 balance sheets more palatable.

We will update this analysis with Q4 data as soon as it is available in its entirety.

 


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Sat, 02/20/2010 - 18:12 | Link to Comment Zippyin Annapolis
Zippyin Annapolis's picture

If you want a real tour of the impact of corporate fantasyland accounting on aggregated corporate liquidity throw in the financials which are I believe 17% of the market. Woops our "cash" for investment is really fairy dust accounting entry. Not good.

Sat, 02/20/2010 - 20:28 | Link to Comment Missing_Link
Missing_Link's picture

You say "fairy dust" like it's a bad thing.

Sat, 02/20/2010 - 21:35 | Link to Comment Careless Whisper
Careless Whisper's picture

he prolly meant to say angel dust accounting.

Sun, 02/21/2010 - 02:16 | Link to Comment Get_to_the_choppa
Get_to_the_choppa's picture

Nah, everyone knows banksters love white girl...and I don't mean caucasian females...

Sat, 02/20/2010 - 21:47 | Link to Comment Doug
Doug's picture

Very funny!  LOL

Sat, 02/20/2010 - 18:19 | Link to Comment jdrose1985
jdrose1985's picture

Hmm. Astounding work TD..

And I had just been taking the cash surplus story for granted until now...

After reading all the headlines regarding looming M+A activity and cash rich businesses, I feel violated once again.

Surreal.

Sat, 02/20/2010 - 21:17 | Link to Comment Dirtt
Dirtt's picture

I didn't believe it but not because I had any clue of how to begin to prove it.  It just falls under the same category as the 'hockey stick' which means it didn't pass my smell test.

Scientific eh.  The smell had been stuck in DefCon1 since the summer of 2006.  The smell of chicken chit and Sunday morning Frat house puke is in the DefCon 2-3 category.

Sat, 02/20/2010 - 18:33 | Link to Comment Anonymous
Sat, 02/20/2010 - 21:48 | Link to Comment Zippyin Annapolis
Zippyin Annapolis's picture

Book and tax numbers are always different--the government wants to tax the difference --but only if it is in their favor!

Sat, 02/20/2010 - 18:39 | Link to Comment RobotTrader
RobotTrader's picture

All that matters is whether or not institutions are buying or selling.

Yesterday, they were buying J.C. Penney on a record volume breakout over the 50-day off a lengthy consolidation:

I have no idea what JCP's P/E ratio is, how much cash they have, or what their cash flow is.  Probably just some hungry institutions who are selling bonds and need a place to park it.

In this case, they chose JCP because of its "4 days to cover" short position, and the bears have been piling on this thing for months.

Good enough excuse to incite a short squeeze, eh???

Sat, 02/20/2010 - 19:58 | Link to Comment deadhead
deadhead's picture

nice observation robo

Sat, 02/20/2010 - 20:26 | Link to Comment Anonymous
Sat, 02/20/2010 - 21:25 | Link to Comment Dirtt
Dirtt's picture

A company peddling rubber donuts is staring down a 35%+ sh. int. Why live a boring life when real life train wrecks in super slow mo are abound?

Sat, 02/20/2010 - 18:47 | Link to Comment john_connor
john_connor's picture

Nice work, TD.

The accounting gimmeckry is a part of the assorted bs and fraud that must be rooted out before we have a recovery.

Sat, 02/20/2010 - 20:07 | Link to Comment deadhead
deadhead's picture

+100

It just kills me that American business has gone from a model where one's word and handshake, as well as one's committment to truth and full disclosure, were the order of the day and those characteristics were highly valued.  Not only were they valued, but if you broke away from that model your name was mud and you were phucked. 

We have come close to completely reversing course and the results of this are eminently clear.  As John says above, the bullshit and fraud must stop.

Our country's business (and political) leaders are for the most part a sorry bunch of bullshit artists and con men.  Our current descent into the abyss of failed civilizations is in large part due to the loss and disregard of the fundamental value of telling the truth to others as well as oneself.

Sat, 02/20/2010 - 21:03 | Link to Comment putbuyer
putbuyer's picture

To further. I have always wondered how we have survived as a population, as so - so many manufacturing jobs left for the orient in the last 2 decades+.

I wonder if there is too many people on earth to sustain?

My cabin is almost ready to use. 14 x 24 and just a wood stove.

Live free of die...

Sat, 02/20/2010 - 21:26 | Link to Comment ZeroPower
ZeroPower's picture

I get it. Cabin with canned beans, some blocks of gold, and ammo.

You do realize you wont be able to browse ZH inside?

Sun, 02/21/2010 - 14:24 | Link to Comment TheGoodDoctor
TheGoodDoctor's picture

He'll have his iphone. Besides I thought that ZH is getting an iphone app right?

Sat, 02/20/2010 - 21:27 | Link to Comment Dirtt
Dirtt's picture

Words of wisdom from war torn places around the world...toilet paper.

Sat, 02/20/2010 - 21:52 | Link to Comment Anonymous
Sun, 02/21/2010 - 09:31 | Link to Comment Yes We Can. But...
Yes We Can. But Lets Not.'s picture

Luv to see a pic of your cabin.

Sat, 02/20/2010 - 21:59 | Link to Comment Doug
Doug's picture

Oh what a tangled web we weave, when first we practice to deceive.

Sir Walter Scott Jr.

Sat, 02/20/2010 - 23:52 | Link to Comment velobabe
velobabe's picture

head, i don't know dick about this topic. does it have anything to do with an investor that has a lot of money? or are you guys talking about the cause and effect this will have on BIG publicly traded companies and that is reason for debate? or can this trickle into the system and effect the little guy financially?

you need to smile.

http://www.youtube.com/watch?v=Xbt30UnzRWw

Sun, 02/21/2010 - 02:21 | Link to Comment Get_to_the_choppa
Get_to_the_choppa's picture

It's that last part that's really crucial...these guys have started to believe the lies they tell themselves.

Sun, 02/21/2010 - 14:03 | Link to Comment Anonymous
Mon, 02/22/2010 - 10:42 | Link to Comment Anonymous
Mon, 02/22/2010 - 11:22 | Link to Comment Anonymous
Sun, 02/21/2010 - 11:30 | Link to Comment Anonymous
Mon, 02/22/2010 - 05:14 | Link to Comment Anonymous
Sat, 02/20/2010 - 18:47 | Link to Comment Anonymous
Sat, 02/20/2010 - 18:56 | Link to Comment Anonymous
Sat, 02/20/2010 - 21:07 | Link to Comment Assetman
Assetman's picture

Apparently I don't get it either, anon.

Withholding cap ex and lowering working capital is a business decision, usually signaling that a company is going into cash conservation mode.  That has been the modus operandi for many companies since 2008.  I just don't see that as accounting gimmicktry, the way I see acceleraing revenue recognition, or deferring a declining asset value as gimmickty.

Interestingly enough, the cap ex and working capital trends do illustrate a very imporant point-- those companies still aren't confident that end demand will be able to sustain itself into the future.  Otherwise, they would acquire, invest, and/or expand their working capital balances.

I'd be a lot more concerned that a company was building cash by issuing equity, raising debt, or selling valuable equipment.   Of course, many companies have expanded their working capital and cap-ex spending on the basis of greater confidence-- only to see demand not appear.  That's would what you would call a bad business decision.

Sat, 02/20/2010 - 21:52 | Link to Comment Zippyin Annapolis
Zippyin Annapolis's picture

good analysis--

Sat, 02/20/2010 - 22:52 | Link to Comment Hephasteus
Hephasteus's picture

That's why they have green shoots spell. To try to get people to do that and get themselves in trouble so they can come in and buy up. It's like saying it's all safe and good, go for a jog and 2 miles into your jog you get attacked by zombies and you're exhausted.

Sun, 02/21/2010 - 02:12 | Link to Comment faustian bargain
faustian bargain's picture

goddamn zombies. I hate when that happens.

Sun, 02/21/2010 - 14:55 | Link to Comment TheGoodDoctor
TheGoodDoctor's picture

You mean the banks right? :)

Sun, 02/21/2010 - 17:56 | Link to Comment faustian bargain
faustian bargain's picture

them too.

Sun, 02/21/2010 - 04:28 | Link to Comment theadr
theadr's picture

Businesses are "waiting" for the "lowest price" until they start CAPEX.  Better not wait too long:  Elimination of weaker firms will lead to monopoly pricing power.

Sun, 02/21/2010 - 04:49 | Link to Comment Anonymous
Sun, 02/21/2010 - 08:38 | Link to Comment Anonymous
Sun, 02/21/2010 - 14:01 | Link to Comment Anonymous
Sun, 02/21/2010 - 15:32 | Link to Comment Assetman
Assetman's picture

Cute.  But no.

You can't have a declining asset value if you don't own the thing that depreciates.  You are making a business decision on whether to own the equipment or not.

Though inflationists would have a problem with the extra cash on hand in the first place.

Sun, 02/21/2010 - 16:17 | Link to Comment Anonymous
Sat, 02/20/2010 - 19:04 | Link to Comment Astute Investor
Astute Investor's picture

Excellent read!  The obsession with FCF, FCF yield is often misguided.  Strong cash flow is certainly a good thing.  However, it depends which levers are pushed and pulled to generate cash flow and whether it is driven by skimping on investments.  Cut capex to the bone (funding only maintenance capex), shorten DSO for A/R and inventories while stretching your payables...and VOILA!!  Enormous FCF.  Unfortunately, this strategy can't last forever.  You can't generate strong top-line growth going forward if capex funding is less than depreciation and W/C is cut back.

Sat, 02/20/2010 - 23:14 | Link to Comment Anonymous
Sun, 02/21/2010 - 10:31 | Link to Comment Anonymous
Sun, 02/21/2010 - 00:15 | Link to Comment tkoski6600
tkoski6600's picture

Agreed.  Well done, TD.

Sat, 02/20/2010 - 19:19 | Link to Comment BS Inc.
BS Inc.'s picture

This means that companies will have to spend an incremental $55 billion over time just to catch up to the PP&E trendline, let alone to add incremental cash generating assets. And since the immediate IRR for organic capex is traditionally much higher than for external acquisitions (with some notable exceptions), it is only after this catch-up has been accomplished, that the S&P500 companies will be truly seeking M&A opportunities, as opposed to what the mainstream media will have you believe.

But, why would the mainstream media say something if it wasn't true?

Very nice analysis.

Sat, 02/20/2010 - 19:39 | Link to Comment Anonymous
Sat, 02/20/2010 - 19:43 | Link to Comment doolittlegeorge
doolittlegeorge's picture

actually of course what matters is where the cash comes from.  if you don't have that you don't have the cash "claims" in the first place.  insofar as JC Penney is concerned of course they own Eckerd's drug store chain which needless to say "generate cash."  combine with a pretty much worthless retailer that you run like an 19th century sweat shop and you have a VERY good use for all that "phantom cash."  of course this piece is ridiculous because equities themselves represent "phantom cash" which so long as the Fed decides the dollar itself "is a phantom" makes this supposedly "unreal money" of equities very real indeed.  in other words "the song remains the same":  this is and always has been a story about debt and the debt markets.  in short:  screw the banks and everything will be fine, just be careful that you "screw them" in the right way.  how can anyone possibly argue that the government is failing in its approach?  so far only a few dead IRS agents.  drape a flag over 'em and call 'em heroes.

Sat, 02/20/2010 - 19:48 | Link to Comment Anonymous
Sat, 02/20/2010 - 20:11 | Link to Comment deadhead
deadhead's picture

zh also addressed this cash hoarding in a previous article by noting that fasb 157 (or whatever the number) was going to force companies to set aside large reserves for off balance sheet liabilities which had to come on the books....
meaning that the cash was already spoken for....

to be helpful, it is FASB 166/167 dealing with OBS items.  additionally, the FDIC ruled in mid December 2009 that they are waiving capital requirements for one and one half years for these incoming assets.

Sat, 02/20/2010 - 19:53 | Link to Comment Fish Gone Bad
Fish Gone Bad's picture

Denninger put up a fairly scary story.  Citigroup may not allow people to take money out of their checking accounts (http://market-ticker.denninger.net/archives/1985-Citibank-No-More-DDA-Ac...).  Since all the banks act the same, it might be interesting to see if any other bank is doing the same thing.

Sat, 02/20/2010 - 22:19 | Link to Comment drbill
drbill's picture

Its only scary if you still have money in one of the TBTF. Otherwise, I think its another jolt to the braindead sheeple. Eventually they'll be jolted enough and begin to wake up!

Sun, 02/21/2010 - 13:20 | Link to Comment arnoldsimage
arnoldsimage's picture

sorry... it is quite apparent they will never wake up.

Sat, 02/20/2010 - 19:53 | Link to Comment Anonymous
Sat, 02/20/2010 - 21:56 | Link to Comment Doug
Doug's picture

+100

Sat, 02/20/2010 - 19:56 | Link to Comment mhhe
mhhe's picture

 

OT:

 

Ron Paul wins presidential straw poll at CPAC

http://www.cnn.com/2010/POLITICS/02/20/conservatives.meeting/?hpt=T1

 

Sun, 02/21/2010 - 03:48 | Link to Comment jeff montanye
jeff montanye's picture

go ron!  i hope they support his foreign, drug war, national security and transparency policies too (doubt it).

Sun, 02/21/2010 - 12:56 | Link to Comment moneymutt
moneymutt's picture

paulites stacked the CPAC conf, does not reflect general Repub or Tea Party sentiment in regards to Paul...but hey, wish it did.

Sat, 02/20/2010 - 20:05 | Link to Comment Anonymous
Sun, 02/21/2010 - 15:42 | Link to Comment Assetman
Assetman's picture

That's a very good observation.  I'd gather that much of the bonus stuff was baked in, thanks to a overwhelming liquidity-based recovery. 

But letting cash sit idle is a sign that management isn't sure that postitive momentum will follow through.  What might be even more scary is to see companies raise cash through equity issuance... and see managment just sit on that cash.  I know this is happening with many REITs and banks... don't know if that's the case anywhere else.

Sat, 02/20/2010 - 20:05 | Link to Comment Anonymous
Sat, 02/20/2010 - 20:32 | Link to Comment Anonymous
Sat, 02/20/2010 - 20:37 | Link to Comment Miles Kendig
Miles Kendig's picture

Reading this I have had a minor revelation.  After a career in government I had thought that one of the greatest oxymoron's was "government standards" until I came across "accounting standards".  Heck, accounting standards may even surpasses loan standards and approach the king, self regulating markets.

Sat, 02/20/2010 - 21:46 | Link to Comment ZeroPower
ZeroPower's picture

IFRS>FASB

Sat, 02/20/2010 - 20:36 | Link to Comment waterdog
waterdog's picture

I do not believe that investors like Warren Buffet are fooled by any balance sheet. I do believe that 90% of investors are fooled by a balance sheet.

S&P is a spin doctor. The post suggest that the assumption by spin doctors is a fallacy when it comes to providing investment strategy. The post is correct. Anyone who takes anything that the S&P suggests is investment advice is a fool.

For many many years manufacturers have complained that the IRS code related to depreciation and amortization was unjust. They had a good argument that when a company spends $125 million in cash to expand a manufacturing facility, the company should be able to expense the total amount in the year of disbursement; instead of a method based on unit sales.

the IRS was starting to come around to the arguement before the world came to a screeching halt.

Depreciation has nothing to do with the condition of a piece of manufacturing equipment. A piece of equipment depreciated over a 5 year period is not worthless at the end of the 5 year period. In fact, the equipment is in just as good of shape 5 years after it was first placed into operation. The reason is the constant repairs being made to the equipment to keep it in top running order. Most repairs to equipment are depreciated over another 5 year period. So, a $125 million piece of equipment that consumes $25 million in preventative maintenance every year has a useful life of 20 years. If the item produced still has a market 20 years later.

 

During the frenzy of 2004 through 2007, many manufacturing companies were sucked into easy money and strong demand. They expanded facilities to produce additional inventory and/or new products. Then everything went to hell. There was no demand for their products. Depreciation via IRS code went to hell. The equipment was no longer needed. The equipment was useless. The equipment needed to be taken off the books. No longer was there a need for preventative maintenance. Large equipment expenses were applied to the books.

A/R were being paid off. No raw materials were being purchased. Payroll was slashed. Cash was building up.

That is not a reason to invest in a company unless one thinks that S&P is not a spin doctor.

You want to make some easy money? Go to any manufacturing company and audit the tangible personal property tax returns. What you will find is a massive tax refund due to the company. The refund is caused by equipment that is no longer being used but is still on the books for depreciation purposes. Many times the equipment is no longer on the premises because it has been scrapped. Equipment not used because it has become obsolete, or, useless is not subject to tangible personal property tax.

99% of all CPA's are fools. They complete returns based on balance sheets. The balance sheet shows a depreciable asset, they pay tax on it, without ever checking to see if the equipment actually exist.

It makes total sense that manufacturing companies are accumulating massive amounts of cash. It makes no sense for the accumulation of cash to be a factor for investment.

 

 

 

 

Sat, 02/20/2010 - 20:50 | Link to Comment broker5208CanSuxMY D
broker5208CanSuxMY D's picture

I do not believe that investors like Warren Buffet are fooled by any balance sheet. I do believe that 90% of investors are fooled by a balance sheet.

 

completely agree. The fools look at Fundamentals, while in some instances it can be worthwhile, in the long-run it's not. This is all a game, it's win or lose. I choose to win, so i'm a technical man. Charts don't lie.

Sat, 02/20/2010 - 20:53 | Link to Comment the grateful un...
the grateful unemployed's picture

Microsoft has been cash rich for years, and what good has that done them?

Sat, 02/20/2010 - 21:36 | Link to Comment Dirtt
Dirtt's picture

They built a wall around their brand name?

Sat, 02/20/2010 - 21:44 | Link to Comment ratava
ratava's picture

they got clueless MBA idiot Ballmer at the wheel, what do you think?

Sat, 02/20/2010 - 21:54 | Link to Comment John McCloy
John McCloy's picture

   I see Microsoft becoming the AOL cautionary tale in the next decade. 

Sat, 02/20/2010 - 21:37 | Link to Comment Anonymous
Sun, 02/21/2010 - 01:01 | Link to Comment Anonymous
Sun, 02/21/2010 - 13:12 | Link to Comment moneymutt
moneymutt's picture

maybe all the management class of these companies are making enough money to stimulate the economy, because the workers are not...either they are working harder for less wages, have had their wages and hours cut, are unemployed for long-periods, or are taking a job for half or third the wages they earned before just to get health insurance before COBRA runs out, or have joined that military, or they are the lucky 1 or 2 precent of execs at the top of a company that is solvent. I just described the state of affairs of 70 percent of economic demand in this country....hope the money the 1 or 2 percent is making can make up for the sorry state of the rest..we could double our govt spending on military and social programs and infrastructure and still not remotely cover the loss in this 70 percent of demand. Add to this the attitude of deleveraging of everyone, consumer reducing debt, companies not investing in future due to slack demand...and we have a depression, the fact that consumers and companies like to have cash in a depression is no surprise.

Sun, 02/21/2010 - 13:56 | Link to Comment Anonymous
Sat, 02/20/2010 - 21:40 | Link to Comment Dirtt
Dirtt's picture

Maybe next year we can lobby Miss America to include iron clad and transparent 10-K's with world peace.

Sun, 02/21/2010 - 09:45 | Link to Comment Yes We Can. But...
Yes We Can. But Lets Not.'s picture

That ain't gonna happen.  We need a Miss Zero Hedge Contest - The World's Brainiest Babes...

Mon, 02/22/2010 - 04:47 | Link to Comment Anonymous
Sat, 02/20/2010 - 21:44 | Link to Comment ZeroPower
ZeroPower's picture

Tyler,

You have GAAP as one of your tags for this post, yet dont mention any of these 'GAAP Gimmicks'. While this post reveals key information i will not argue with, i think the conclusion you try and lead into is not the (more) relevant one to today's market workings.

Going in, lets remember quarter after quarter, 10Q after 10Q, companies seek to get out results which are better than expected. All about management getting their short term incentives at the expense of long-term stakeholders. Here is where the accounting wizards come in.

Let me add for those readers which were lucky enough to not waste a few months of their lives studying GAAP handbooks, there is a section called Earnings Management. Not to be confused with earnings manipulation, e-mgmt revolves around executives choosing an accounting system which will report their results in the most favourable ways possible.

During the 2008 meltdown through 2009, there is no doubt most companies took a big bath (not just financial ones) and hence are able to show better results this last quarter or 2. As well, every single CF (operating, investing, financing) is generated to simply look as though it was generated by shifting the revenues and income from other places of the firm. Yes, A/R might have been sold to go off B/S. Yes, A/P might have been delayed to increase income.

All these gimmicks are done year after year by the most 'ethical' of the 'Top5' acctg firms. In some years companies rely on management of their 10Ks a bit less, and in some years more. Im assuming the year following horrible results they will indeed rely more on such tactics.

Sat, 02/20/2010 - 21:43 | Link to Comment ratava
ratava's picture

everything is perfectly fine in the US of awesome A. shouldn't you be rambling about Greece instead of this? the treasury/fed/GS circlejerk is jealous of Euro so they keep spiking up the sovereign CDS with printed money, making sure Dollar stays the only reserve currency forever and after.

Sat, 02/20/2010 - 21:50 | Link to Comment spekulatn
Sun, 02/21/2010 - 14:46 | Link to Comment Anonymous
Sat, 02/20/2010 - 22:18 | Link to Comment Anonymous
Sun, 02/21/2010 - 11:36 | Link to Comment the grateful un...
the grateful unemployed's picture

the raid on equity, aka the housing bubble, is macroecon 101, isn't it. bernanke railing about a global savings glut. i didn't know macro and micro econ were mutually exclusive until these guys took over.

Sat, 02/20/2010 - 22:30 | Link to Comment californiagirl
californiagirl's picture
Great charts!  However, my conclusions are quite different.  The accounting is a reflection of the reality, not gimmicks.  Customer demand began to decline in the summer of 2008 and the decline did not reverse itself as usual in September 2008.  As previously billed receivables were collected, along with the drop in demand, A/R balances declined. Due to the alarming decrease in demand, businesses started to cut costs and ramp down production.  However, inventories still continued to increase for a while because the decrease in production did not decline as rapidly as demand. We still had hope that the consumer would spend during the holidays.  Reality finally sunk in after a worse than expected 2008 Christmas season, at which point manufacturing took a severe dive, inventory declines started to outpace declines in demand, and Capex budgets were frozen.  Capex spending appears to have continued until Q4-2008.  However, this is misleading because a lot of capex equipment has long lead-times, sometimes in excess of 6 months.  So items ordered in the first half of 2008 may not have been received (and posted on the books) until the second half of 2008. To make matters worse, GAAP requires that equipment begins depreciating when placed in service.  Large, complex machinery (which takes months to install and become operational) can sit on the books for quite a while before it begins depreciating. Therefore, depreciation can continue to increase for a few months after Capex has been reduced.  Being a CPA with experience in corporate accounting/finance, including responsibility for SEC reporting, and as a current co-owner of a manufacturing business in Silicon Valley (yes, a few of us actually still manufacture in California), this is exactly what occurred.  Our products fall into the Capex category of many large high tech companies.  Due to long lead times and non-cancelable orders from our customers, we were still manufacturing for months after booking began to fall and finally dived off of a cliff in January 2009. Due to the decline in bookings, we also froze our capex as cash conservation in order to ride out a prolonged recession became the primary concern.
Sat, 02/20/2010 - 23:26 | Link to Comment Anonymous
Sat, 02/20/2010 - 23:44 | Link to Comment the grateful un...
the grateful unemployed's picture

they used to speak of the cash burn ratio in startups. Does that apply to companies which are retrenching?

Sun, 02/21/2010 - 00:11 | Link to Comment Roscoe
Roscoe's picture

Good post from the front lines CG. Your post's business timeline ends in January 2009; can you give an idea of what your manufacturing life has been like in the months since then? Do you see or sense genuine signs of recovery? Are order rates picking up? If so, where are the orders coming from, in general? And finally, what's the talk like in Silicon Valley right now from the people you trust?

Sat, 02/20/2010 - 22:33 | Link to Comment Hephasteus
Hephasteus's picture

Wow those capital expenditure spikes that occur every september and october are not going to be able to spike if there's no cash in the bank.

Sun, 02/21/2010 - 01:16 | Link to Comment ShankyS
ShankyS's picture

I'm gonna est U6 unemployment at 35% max before this is over. There will be no solution other than massive devaluation to a point we can manufacture competitively again. There is no other solution I see. Massive default will only go so far. We're in deep shit. Screw gold biatches, I''m thinking seeds and ammo will the the best barter items in the future. You may want to pick up a vespa or a motercycle as well.

Sun, 02/21/2010 - 01:28 | Link to Comment Anonymous
Sun, 02/21/2010 - 14:54 | Link to Comment Kayman
Kayman's picture

Hello Anon 239077

You (unintentionally) highlighted the fatal flaw. We have been spun the LIE that the USA can be a SERVICE ECONOMY, and can let MANUFACTURING shrink.

Have you noticed a MANUFACTURING ECONOMY- CHINA has all the jobs that a SERVICE ECONOMY  requires to service ?

Taking in each other's laundry does not an economy nor a country make. Period.

AS WALMART GROWS, AMERICA DIES. 

Sun, 02/21/2010 - 18:04 | Link to Comment Anonymous
Sun, 02/21/2010 - 20:35 | Link to Comment ZeroPower
ZeroPower's picture

Each country has its competitive advantage. Word.

Sun, 02/21/2010 - 21:23 | Link to Comment Kayman
Kayman's picture

While your argument is plausible, it is  repetition of an economic fallacy- the very one that led us to the "outsourcing" of American jobs.

Try buying a couple of hundred serviced acres, move in a couple of barber shops and see how many jobs, manufacturing, service, or otherwise arrive to support the barbers.

Conversely, set up a manufacturing plant (or a resource industry) and see how many services flock in to support it.

Manufacturing begets service industries, government, etc. The economic problem facing us, is the 19% (manufacturing and resource industries) can no longer carry the burden of the other 81%. 

That, sir, is the problem. And I am not whining.

Thanks for expressing your point of view. But you are dead wrong.

As Walmart rises, America falls.

And I am all for trade, as long as it is balanced, two-way trade, absolute or comparative. But I cannot countenance the current "BEGGAR-THY-NEIGHBOR" absurdity this country's politicians have contrived with China.

U.S. manufacturing was "outsourced" to China, thereby eliminating all domestic laws- say, minimum wages and benefits, pollution control, safety, and security.  This also "outsourced" the American tax base.

Sun, 02/21/2010 - 22:08 | Link to Comment faustian bargain
faustian bargain's picture

the US also 'outsourced' inflation, which is what TPTB really wanted to do. All that free money, and they hid the blimp by loaning it to China...until...

Sun, 02/21/2010 - 01:53 | Link to Comment Hephasteus
Sun, 02/21/2010 - 04:34 | Link to Comment Anonymous
Sun, 02/21/2010 - 09:33 | Link to Comment Anonymous
Sun, 02/21/2010 - 09:38 | Link to Comment Anonymous
Sun, 02/21/2010 - 15:52 | Link to Comment Assetman
Assetman's picture

Yep, that's possible.  Some internet/B2B companies with no earnings (and marginal business plans) saw the handwriting on the wall in 1999.

What did they do?  They issued equity like there was no tomorrow, adjusted their business plan to minimize cash burn-- then just sat on the mountain of cash.  Some survived, and some were acquired, because of their available cash balances.

Unfortunately this time around, many of the companies hoarding cash have sigificant interest/debt burdens... and the cash will burn more quickly.

Sun, 02/21/2010 - 10:59 | Link to Comment Anonymous
Sun, 02/21/2010 - 11:41 | Link to Comment Anonymous
Sun, 02/21/2010 - 12:10 | Link to Comment threehundredthi...
threehundredthirtythree's picture

I read this once:

 

A mom and pop hotel man in texas owed his bookie $100. He had till midnight to get it or else the bookie was gonna send Guido to beat it out of him. He was broke, and his flea bag filthy hotel went unoccupied since he had not money for repair. Luckily, a trucker walked in tired from a 2 day trip, wanting simply a bed to sleep on. Noticing the poor upkeep, the tired trucker gave the hotel man a $100 with the agreement that he would first look a the room. As the money traded hands, and the man walked away, in walked Guido. He was quickly given the $100 which he quickly gave to the bookie. The bookie, owing money on his cadillac payment, immediately ran that $100 to the dealer. The dealer, suffering from the bad economy, owed the bank, and he immediately ran the money off to the bank. The banker, owing $100 to his hooker, hurried to pay her for fear of being exposed of his sins. The hooker, took the money and ran fast to the hotel man, where she gave him $100 to pay for the use of a room for clients. The trucker returned from the room, and said it was filthy, demanding his $100 back. He walked away, and everyone was happy because they were paid up.

 

Welcome to the american economy.

Sun, 02/21/2010 - 15:01 | Link to Comment Kayman
Kayman's picture

Hey threehundredthi...

So you are trying to tell me Helicopter Ben got started driving truck....

Great story.

Sun, 02/21/2010 - 12:12 | Link to Comment threehundredthi...
threehundredthirtythree's picture

typos fixed: Sorry

 

I read this once:

 

A mom and pop hotel man in texas owed his bookie $100. He had till midnight to get it or else the bookie was gonna send Guido to beat it out of him. He was broke, and his flea bag filthy hotel went unoccupied since he had not money for repair. Luckily, a trucker walked in tired from a 2 day trip, wanting simply a bed to sleep on. Noticing the poor upkeep, the tired trucker gave the hotel man a $100 with the agreement that he would first look "at" the room. As the money traded hands, and the man walked away, in walked Guido. He was quickly given the $100 which he quickly gave to the bookie. The bookie, owing money on his cadillac payment, immediately ran that $100 to the dealer. The dealer, suffering from the bad economy, owed the bank, and he immediately ran the money off to the bank. The banker, owing $100 to his hooker, hurried to pay her for fear of being exposed of his sins. The hooker, took the money and ran fast to the hotel man, where she gave him $100 to pay for the use of a room for clients. The trucker returned from the room, and said it was filthy, demanding his $100 back. He walked away, and everyone was happy because they were paid up.

 

Welcome to the american economy

Sun, 02/21/2010 - 13:38 | Link to Comment moneymutt
moneymutt's picture

ummmm...in that story everybody quickly paid their bills....if you think economy is going to expand, people do that, but really, the motel guy figures he has got nothing to lose, given he has no motel business reputation to maintain any longer, especially given even a desperate trucker won't pay, then motel keeps his $100, defaults on trucker, who thereby sleeps in cab and never visits any motel for a shower, so real motel owner can't pay his local Guido...etc...

What you described was US and world economy in August 2008....

Sun, 02/21/2010 - 18:11 | Link to Comment faustian bargain
faustian bargain's picture

Why did the motel guy owe the bookie in the first place?

Sun, 02/21/2010 - 15:06 | Link to Comment Kayman
Kayman's picture

Hello again threehundredthi...

Sorry, but if it was Helicopter Ben he would have said  "the room is filthy but keep the $100 anyway".

Sun, 02/21/2010 - 22:10 | Link to Comment faustian bargain
faustian bargain's picture

And here's an extra million, why don't you clean this place up. (wink wink)

Sun, 02/21/2010 - 12:38 | Link to Comment Lux Fiat
Lux Fiat's picture

Excellent story, and one of the reasons that I enjoy reading ZH - it delves beyond the usual superfluous (and often incorrect) stories.

However, there could be another take on the cash build up due to cutting capex.  In the same way that one could argue that China has massive overcapacity, it could also be argued that in the shorter term, US businesses also have excess capacity as it seems US consumers have finally hit the debt wall.  Many local and state governments are also hitting the wall or about to.  And who knows when the Fed gov't will hit, but it will likely be sooner than later if it maintains its free-spending ways.

In addition to hitting the debt wall, consumerism in the US is also hitting the changing demographics wall.  Like heavy debt, this situation will take a long time to unwind and reverse.

In this kind of environment, demand may be impaired for an extended time.  Reducing capex makes sense.  Also, if demand will be weak, then growth will not likely be attained via organic means [except in the case of exceptional mgmt, or in those few areas where there is real demand growth], which will favor growth via acquisition.

Like the Chinese, US companies may also be concerned as to the purchasing power of their cash "hoards" and looking to spend them on things that have a better chance of retaining value over the longer-term.  Then again, maybe I'm just giving them to much credit.

From this perspective, the cash "buildup" via capex reductions makes some sense, and acquisitions may very well be in the picture, although at much more muted valuations than in 2007.  

Also, there is certainly the risk of another liquidity crunch, and this corporate behaviour is certainly rational in light of that possibility. 

Sun, 02/21/2010 - 13:31 | Link to Comment moneymutt
moneymutt's picture

I agree with yours and similar comment above, I believe it is some of both, rational tight policy given unsure times and gimmicks that enrich management class, who, of course, are in charge. Just like why doctors order too many tests and procedures, sure some of it is for the patients interest, some of it is defensive medicine to avoid lawsuits, but some of it is also, they make more money when they do. Hmmm, I can give my patient the most conservative care possible, I can cover my butt from a lawsuit, and I can make more money....or I can look at high cost and diminishing returns of various tests and procedures, possibly miss a one in 10,000 thing my patient has, and make less money....what will I do?

Same goes for execs of companies...I can tuck in the squeeze the company for every last ounce of cash that will be handy in a crisis, and also use accounting methods to make even more money appear and thus get better bonuses, or I could fore-go bonuses,look at the long-term interests of the business and roll money into needed functions, avoid risk, keep core of experienced and top notch workers happy and pick up huge market share from my competitors during a tough times, so company and maybe me makes big money in the  future.....I think big bonuses at Christmas time wins....and if company is doing even worse, the best long-term decisions for company which is likely throwing most over-paid management out and slashing their income while, keeping core workers in, is not going to implemented by management...they would rather keep their jobs and run company into ground, at least, unlike laid off workers, making good money until the company is completely gone few years down the line. 

Sun, 02/21/2010 - 14:46 | Link to Comment Lux Fiat
Lux Fiat's picture

Yes, in addition to capex reductions and "cash" increases being geared toward corporate preservation, never underestimate the lure to mgmt of fake improved performance, and associated increases in bonuses.  Corporate boards have largely been useless and AWOL. 

Mon, 02/22/2010 - 21:23 | Link to Comment Anonymous
Mon, 02/22/2010 - 21:30 | Link to Comment berlinjames02
berlinjames02's picture

Lux,
I agree. As I was reading, I kept thinking about the numbers in the context of deleveraging and excess capacity. Do US firms have tons of spare capacity sitting around that they will be expensing for the next 10 years? Or is it more like 2-3 years since the US manufacturing base isn't exactly robust and the depreciable assets have much shorter lives. (ex Starbuck's coffee grinders/pots.)

I wondering if Tyler could provide us with a sense of the size of depreciation expense as a percent of total assets? Or what percent of total assets that accumulated depreciation represents?

Sun, 02/21/2010 - 12:47 | Link to Comment plocequ1
plocequ1's picture

OK, We know there is accounting minipulation, Fraud and fudging. Please advise what happens next besides all our money going to the rich.

Sun, 02/21/2010 - 13:31 | Link to Comment SDRII
SDRII's picture

Look no further than the steels and Alcoa for the working capital squeeze. Managing working capital is a 2008-present euphamism for firing people. As for cash on balance sheet another compoennt is the record corproate debt issuance of 2009. How much of it was companies simply running for the cash register while the going was good?  

Sun, 02/21/2010 - 14:33 | Link to Comment TheGoodDoctor
TheGoodDoctor's picture

So, what I get from this is:

1. Cash is king.

2. Deflation is still on the table.

3. The Bush tax cuts for businesses made this possible. And isn't Obama looking to extend the acceleration of depreciation of existing and/or new equipment etc.? Won't this make the problem worse in the hopes of jump starting inventory reduction/manufacturing?

4. This is another reason that most equities are over valued. Or perhaps large caps in general.

5. How can they pay dividends then or increase them if these shenanigans are going on?

6. The M&A info that Tyler mentions seems to jibe with what David Faber said on Cramer's Friday show I believe it was. That he didn't think M&A was going to be too hot this year. Could he know this and this may be the reason?

7. If there is M&A it will strictly be by stock acquisition then?

8. Tyler is David Faber. :p (have to inject some humor)

 

Sun, 02/21/2010 - 15:36 | Link to Comment Anonymous
Sun, 02/21/2010 - 16:02 | Link to Comment Anonymous
Sun, 02/21/2010 - 17:59 | Link to Comment buzzsaw99
buzzsaw99's picture

Buy stocks, they only go up.

 

http://www.youtube.com/watch?v=8qrriKcwvlY

Mon, 02/22/2010 - 04:03 | Link to Comment Anonymous
Mon, 02/22/2010 - 07:56 | Link to Comment Anonymous
Mon, 02/22/2010 - 12:39 | Link to Comment Anonymous
Sat, 04/17/2010 - 10:54 | Link to Comment Tom123456
Tom123456's picture

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