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Balance Sheets Before Jobs

By Mark Green

Confoundingly, while a gimpy post-Great Recession U.S. economy can’t find the key to restart its stalled jobs engine, reports are the profitable corporate sector has a $2 trillion cash hoard – sitting idle, not putting Americans back to work.

Sounds illogical, or perhaps untrue – financial news can begin with facts in New York or Chicago that get extrapolated to characterize the rest of a diverse nation, whether appropriate or not.

But the reports are essentially true.

Many large corporations, indeed, are generating nice profits. Smaller operations and mom-and-pops not so much; for many of them times are hard. And little change in that picture is expected anytime soon. Until consumer spending improves, cash-spinning corporations that are meeting market demand with their current workforce will do little or no hiring, and small business will continue to tread water.

“A lot of large multinationals are sitting on a lot of cash,” said Janet Harrah, senior director of the Center for Economic Analysis and Development at Northern Kentucky University’s Haile/US Bank College of Business. “They’ve slashed their workforces. Because their demand is down, they’re functioning as profitably or moreso than before.”

Kentucky has 71 private-sector employers with 1,000 or more workers, Harrah said. About 650 businesses have 250 or more workers. At the other end, 90,000 businesses in the state have three or fewer workers.

“Typically the difference between profit and loss for smaller companies is in a smaller range,” Harrah said. “It is not these companies that are sitting on cash.”

The large multinationals have far greater ability to impact the economy – hiring or laying off 300 workers is equal to 100 small businesses starting up or failing – and they attract the most media coverage.

“When you talk about the economy it’s easy to overgeneralize. Some companies are sitting on cash, but they tend to be large,” Harrah said. “It gets generalized that this is what’s happening with all business, and that’s not the case.”

Richard Dorton, partner in the Kentucky CPA firm Dean Dorton Allen & Ford, which files some 1,000 business tax returns a year, said most of the clients they work with are not experiencing a “recovery” since the end of the recession.

“My impression is that there is not a lot of cash on hand,” Dorton said.

Conditions vary by sector, he said. Healthcare firms and those doing business with them are faring well. Auto manufacturing is recovering.

Construction subcontractors “are just hanging on” – unless they have healthcare or education sector projects. “Which is another indicator that small business is not feeling much improvement,” Dorton said, because small business in good or normal times keeps the construction sector busy.

Loan reforms becoming deal-breakers
Smaller companies tend to be more vigorous job generators, according to Russ Ray, professor of finance at the University of Louisville College of Business. Most large companies are mature and have relatively stable workforces.

“It’s the small companies that are growing at 20 percent, 40 percent, 60 percent a year,” Ray said. “They buy the majority of new assets. … They account for job creation much more than large companies.”

Unfortunately, it is difficult now for these companies to get loans to grow. A too-lenient lending environment before the 2008 economic crisis, which was linked to subprime loans, has now become too restrictive, according to Dorton, who said he’s seen the pendulum swing through multiple cycles in his career.

Paul Johnston, tax director in the Lexington office of the Blue & Co. LLC accounting firm, agrees that loans are more difficult to obtain today.

“It’s much tougher and a drawn out process now to get lenders on board for a deal,” Johnston said, “unless it is a strong cash deal, which we don’t see now.”

Even many businesses of up to $100 million in annual revenue lack cash assets with which to make big transactions. These “medium-size businesses have a hard time (getting loans) because they are not coming to the table with cash deals,” Johnston said.

State businesses “are being very cautious,” said Michael Mountjoy, co-managing partner of Kentucky’s largest accounting firm, Mountjoy Chilton and Medley.

A number of companies have experienced a business rebound, he said, especially in the manufacturing sector and among some service businesses.
“We’re seeing the well-run companies that make money in good times can make a little money when times are not so good, too,” Mountjoy said.

But those that are accumulating assets are in no hurry to hire or pursue expansions.

“Our large and more profitable business clients in the state who are back to the point of making money are strengthening their balance sheets,” Mountjoy said, putting themselves in a better position to act when economic conditions clearly give a greenlight.

“We’re seeing a lot of deleveraging,” he said. “I think it’s not different than you’re seeing with individuals. … They don’t want any more debt than they have to have, even thought interest rates are very low.”

Risk can’t be assessed for planning
A prime reason for the reticence, the business observers all agree, is continuing uncertainty about politically determined economic policy.

“Businesses want to be able make a three- to five-year plan based on the facts as you know them,” Dorton said, “but today it keeps changing.”

Banks want to lend, and businesses want to borrow, and political leaders want the banks to lend, he said, but recent regulations prevent banks from qualifying applicants.

“Small businesses are still worried about uncertainty,” Dorton said. “It’s hard to assess risk when you don’t know the rules you will be playing by.”

His and other major accounting firms also provide consulting services to clients, but they can’t offer guidance past next year because they do not know what federal tax rates will be after the decade-old Bush tax cuts expire or what estate tax policy will be after a current $5 million exemption expires at the end of 2012. Employee healthcare costs cannot be pinned down, and there is discussion of reforming the changes in lending regulations.

“No matter the politics you prefer,” Dorton said, “it would be good to know your rules for the next two to three years, for the next three to five years.”

While there is agreement that the economy is getting better, there is further agreement that conditions are improving more slowly than was anticipated. The growth rate is so low and tenuous enough that disruptions like Japan’s earthquake and tsunami earlier this year and concerns such as an unraveling of Europe’s 20-year-old common currency are legitimate threats to send the economy back into recession.

In Kentucky, as in the rest of the nation, the economy confronts multiple intertwined headwinds.

• Consumer confidence and consumer spending are low.

• State unemployment is high, notched back up in September to 9.7 percent.

• Federal banking reform has made it much harder for individuals and businesses to borrow money for cars, homes, capital investment and hiring.

• Complex healthcare reforms enacted two years ago created cost uncertainty for business because implementation involves several years of regulation writing and has become politicized, further muddying matters.

• Income tax and estate tax rates in the near future are not known, another politicized subject.

• Budget deficits at local, state and federal levels – and even abroad – will likely prompt policy changes that impact business finances.

“Until we can get an understanding of what the playing field will look like, I don’t think (business) people will be willing to take much additional risk,” Dorton said.

Acquisitions include stock repurchase   
Hannah views improved consumer spending as the ultimate cure.
Kentucky consumers are in no mood, though, according to a survey of 500 families this summer by Jennifer Hunter, assistant extension professor for family financial management in the University of Kentucky College of

UK reported many of those polled said they’ve made changes to their spending habits and lifestyle because of the recession:
• 62 percent eat out less often.
• 39 percent shop at discount stores more often.
• 60 percent spend less on themselves or their spouse.
• 40 percent spend less on their

Consumer spending represents 70 percent of the U.S. economy, so those trends will have to change to bring the employment rate up, recharge cash flow at smaller businesses, put construction subcontractors back on worksites, and convince large corporations it’s time to deploy profits into expansion.

Without demand from consumers, Hannah said, publicly held companies whose fiduciary duty is to shareholders will continue to see stock repurchase, dividend payments and strategic acquisitions as their best investments.

Recent earnings report show these decisions are taking place in Kentucky boardrooms.

Humana’s recent third quarter report showed it with $13.58 billion on hand. Earlier this year its board initiated a quarterly dividend and authorized a $1 billion stock buyback program.

Lexmark initiated a quarterly dividend and acquired Dutch business software developer Pallas Athena.­­­­­

Ashland repurchased 1.2 million shares, increased its annual dividend by 17 percent and acquired specialty chemical manufacturer International Specialty Products Inc. for $3.2 billion in an all-cash transaction .
Omnicare, which is moving its headquarters from Northern Kentucky to Cincinnati, has sought to buy Louisville-based rival PharMerica. It repurchased 1.2 million shares and finished the third quarter with $681 million cash on its balance sheet.

General Cable authorized $125 million in share repurchase.
Brown-Forman acquired Maximum Vodka from Altia for undisclosed terms at midyear. By Sept. 1, it had spent $105 million of an authorized $250 million stock repurchases.

Boardroom decisions to prop up stock prices have benefits, Ray said, because they improve the numbers that appear in 401k statements delivered to Kentuckians’ mailboxes.

And consumers need any good news they can get.