Imprecision and trade-offs are unavoidable. Determining the right level of financial reserves requires difficult judgments about the company’s prospects and its access to capital markets. Unfortunately, there is no mechanical formula or software package a CFO can use to replace the arbitrary ratios of the past. Successful management of financial inventories can mean as much for a company’s bottom line as the introduction of JIT. The costs of holding excessive financial reserves can dwarf the costs of bulging physical inventories, and yet insufficient reserves can be more crippling still. Unused debt capacity and excess cash constitute a company’s financial inventory, the reserve it can draw on in time of need. And when all the companies in an industry defer to one another’s financial acumen, they turn into a herd, liable to wander at random. Making its bonds a safe investment for widows and orphans may not be in a company’s best interest. They cling to the security blanket of a superior bond rating or they draw simplistic conclusions from their competitors’ debt-equity and cash-to-sales ratios.īut any resemblance between sound financial policy and these kinds of traditional or imitative approaches is purely coincidental. The fact is, companies continue to base their financial policies on hoary rules and superficial analyses. Traditional rules insist on the value of excess cash when today, liquid investments are more an enticement to piracy than a refuge from disaster. The issue of cash reserves is no less perplexing. Conventional credit analyses take a lender’s perspective: they help to determine how much debt a business can afford to carry rather than how much of its debt capacity a business should use. The existing approaches to this dilemma are inadequate. On the other hand, managers are responsible for protecting themselves from the kind of aggressive lenders who could turn their companies into corporate Brazils. If high leverage creates shareholder value, managers are bound by duty (and the fear of corporate raiders) to take advantage of it. Managers are certainly not responsible for protecting lenders from their own bravado. Today’s junk-bond financiers, merchant bankers, and “credit corporations” offer far more leverage than businesses have historically been comfortable with, and these venturesome lenders pose a difficult problem for management. The old consensus between lenders and corporate borrowers about what constitutes a prudent level of financial reserves has broken down.
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