Resources | Finance and Lending | August 9, 2023

What Does “Trapped Cash” Really Mean?

Trapped cash is a persistent challenge for international corporations and their shareholders. Is there an easy, cost-effective way to optimize these assets?

global currencies

Researchers at Northwestern’s Kellogg School of Management estimate that $5.8 trillion in cash was held by United States companies in 2022. This so-called trapped cash — of which a majority is held offshore — has increased significantly from $1.6 trillion in 2000. Despite efforts to encourage repatriating cash to the US, including the Tax Cuts and Jobs Act, the situation has only escalated. According to industry experts, this is because:

  • Many regions still have lower tax rates than the US, even after corporate tax cuts launched in 2018.
  • Eliminating the US repatriation tax may have backfired. When companies can bring funds home at no cost, it gives them even more incentive to earn cash abroad.
  • Companies are cautious to reinvest or distribute funds due to economic uncertainties resulting from the pandemic, supply chain disruptions, global conflict and rising inflation.
  • Companies may be waiting until the new international regulations, such as the 15% minimum tax rate, take shape before making any changes to their tax structures.

The growth of trapped cash not only raises concerns among governments and investors but also poses drawbacks for the companies themselves. Unlike other assets, offshore cash tends to lie dormant, stifling innovation and investment, jeopardizing future financial performance and encouraging shareholder angst. 

How and why does trapped cash occur, and how can your enterprise leverage this capital for business growth?

What is trapped cash?

Trapped cash describes cash earnings that are held overseas, either due to regulatory constraints or tax rates. As a company grows, it may establish subsidiaries in other countries and accumulate cash balances there. Companies generally categorize cash as trapped if it doesn’t make sense, business-wise, to move it home — either because the process is too difficult or costly. There are two main reasons why cash becomes trapped:

  1. Laws in the foreign jurisdiction may prevent the company from repatriating funds. This is more common in emerging markets where governments may impose restrictive foreign exchange controls. The administrative burden required to move cash out of these countries may also be too high for companies to bother.
  2. Many companies have moved to tax-optimized structures that concentrate cash in countries such as Singapore, Ireland and Switzerland where tax rates are lower. Because taxes on earnings don’t come due until the cash is repatriated, companies have more incentive to accumulate cash in these locales rather than bring it home for reinvestment, dividends or buybacks.

Benefits and risks of overseas cash reserves

There are several reasons why it might be in a company’s best interests to retain trapped cash overseas — the most obvious being the cost savings in paying lower taxes. Building a cash reserve abroad also makes sense if the company plans to continue making investments there. 

But trapped cash also poses risks. Organizations, particularly those among the Global 2000, risk significant impacts on their market capitalization if they wait to address growing overseas accounts. Investors and financial institutions typically disregard foreign cash when assessing a company, which affects valuations, credit ratings and funding access. Increased foreign earnings are viewed as a positive, but investors want to see these earnings reinvested in business operations or distributed as dividends. From an investor’s perspective, extracting as much value as possible from the company’s assets, including foreign assets, should be the goal. 

Cash also can face business risks in the country where it is trapped. For example, if a country’s local currency decreases in value, the company may incur significant losses if the cash is repatriated. In emerging markets where economic downturns have the biggest impact, companies are often subject to evolving laws and restrictions on trapped cash. When subsidiaries distribute and control profits, it may also expose the company to greater risks of financial fraud.

A simpler way to leverage trapped cash

Several factors — such as tax regulations, how a company invests in foreign operations and repatriation costs — are considered when cash is deemed trapped. In each of these situations, a company measures the costs and risks of leveraging cash versus holding it abroad. 

Many companies opt not to leverage trapped cash because solutions are either too complicated or offer meager turns. Banks and consulting firms provide strategies to make use of trapped cash, including special purpose vehicles (SPVs). However, these schemes are often complex and difficult to implement, not to mention posing accounting risks. 

A simpler, faster solution uses trapped cash to fund early payments to your suppliers. In an early payment program, your enterprise funds early invoice payments directly to suppliers in exchange for a discount. This gives suppliers a cash flow boost, which strengthens the supply chain and improves your margins.

C2FO does not influence or facilitate transfers between buyers and suppliers, eliminating regulation concerns. Many leading corporations use C2FO’s Early Pay solution to accelerate cash and boost foreign earnings in operations centers globally. In 2022, the platform provided $78 billion in funding to suppliers using C2FO across 160 countries and 45 currencies. At the same time, leveraging early payments created measurable value for enterprise buyers, including more than $151 million in savings on their invoice payments in Q4 2022.

In summary

Financial leaders can expect the topic of trapped cash to persist as the volume of overseas capital rises year after year. As more companies expand internationally, these businesses probably will continue to optimize beneficial tax structures abroad, even after the 15% minimum tax rate is implemented.

Companies that want to appease investors and optimize the value of foreign assets will look for ways to put this money to use. Thankfully, early payment programs give enterprises like yours an easy, cost-effective way to leverage trapped cash. Foreign earnings, shareholder sentiment and supplier health all stand to benefit

Take advantage of your trapped cash by using it to pay suppliers early — click here to learn more.

This article originally published November 2019, and was updated August 2023.

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