Question

Assume that you are the CEO of a small publicly traded company. The company’s stock price has fallen recently, and you believe that the market does not fully understand the company’s potential. You wonder about ways to increase cash flow for the year. At your direction, your CFO provides you with the following recommendations that are designed to increase your cash flow in the current period. Your hope is that these will bring the stock price back up to where you believe it should be.

1. Lengthen the time taken to pay accounts payable (“lean on the trade”) to increase net cash flows from operating activities.
2. Cut spending on R&D by 10%, which improves cash flow but also operating performance measures.
3. Decrease discretionary spending on marketing and promotion activities.
4. Offer deep discounts (during the last quarter of fiscal year only) to favored customers to provide incentives for them to increase the quantities they purchase from you in the current period.
5. Delay certain capital expenditures to push the cash outflow to a subsequent period.

Evaluate TWO of the CFO’s recommendations. In your evaluation, consider whether each recommendation will increase free cash flow in the short-term and the long-term. Will any of these ideas improve the stock price?

Answer 1

Given below the possible cash flow and stock price  impacts of two of the sggested action points from the CFO;

1. Decrease discretionary spending on marketing and promotion activities. : This is definitely going to increase the current year cash flow as the expense will come down. However, in today's world of cut throat competition, marketing and sales promotion is essential for maintaining the existing customer base and capturing new markets , keeping the product alive in the mind of customers, letting customers know about improved features of product and for launching new products. Effectively marketing and promotion expenses are investments for future sales growth. If that investment is cut down , the sales in immediate future will definitely suffer. The result of this action will be stagnant or negative sales growth , loss of market share and loss of earning. All these impacts will send negative impacts to the market. As the stock price depends not only on the current earling but also the projection of future earnings, the neagtive future earning projections will bring down the stock price.

So the measure may improve the cash flow in the short term , but the cash flow in the long term will be reduced and the effect on stock price will be negative.

2. Delay certain capital expenditures to push the cash outflow to a subsequent period. : This measure will definitely throw some additional cash flow in the short term , but again the long term cash flow will be impacted. As new Capital expenditure in necessary for enhancing market share by introducing new products, to reduce cost of production, to add new feature to a product, to comply to new environmental regulations etc which are absolutely necessary for the growth and survival of the company. The Capital expenditure is an investment for future which will generate substantial additional cash flow in future years. If a company avoids necessary Capital expenditure, it cannot survice in the market for long and will start losing market share and profitability. As a result of defering the capital expenditure the additional cash flows in the future years will be delayed and that will be a bad signal to the market. The stock price will tend to fall in anticipation of delayed return from new capital investment.

So the measure may improve the cash flow in the short term , but the cash flow in the long term will be reduced and the effect on stock price will be negative.