October 2002
Understanding the impact of cash flow
Gene Siciliano, of www.cfoforrent.com, recently asserted: "More companies will fail once an economic recovery has started than will have failed during the preceding recession." A study by a University of Southern California researcher corroborated his view. Based on data from the 1990-91 recession, business bankruptcy filings peaked in 1993 and 1994, well into the subsequent recovery. In fact, failures in 1993 were 70% higher than in 1990, the primary recession year!
Lest we be misunderstood here, we are not saying the economy suffered more damage after the recession ended. We are simply saying that the damage was hidden until the growth race re-ignited. At that point, those who could no longer run the race became visible. How? Their competitors ran away from them once the recovery picked up steam. The effects of the increased competitive pressure simply revealed the truth – many of the wounded would never recover.
What did we learn from those statistics that might shed some light on the reasons for this delayed effect? While that is a bit harder to glean with clarity, there were some interesting observations made during the research. For example, a company with increasing sales – a classic growth company – is always in need of added working capital to finance the manufacture or purchase of their products, the sale to customers, and the waiting period for customers to pay. The more sales a company has, the greater its need for cash to finance this cycle. This need is almost always under-estimated and under-provided. This is why many high growth companies fail. For any seasoned entrepreneur, this is old news.
But note the reverse: companies with shrinking sales have less need to finance unpaid customer accounts, less need to re-build inventories consumed through sales, and often less need for sales staff and other resources. In fact, collecting their existing customer accounts may even result in a short-term increase in cash flow. This increased cash flow may give managers a false sense of security that their company is OK, when it really isn’t.
Only when their resources are depleted, and a meager amount of new accounts receivable is available to collect, and they are faced with a recovering demand that requires the replacement of resources, do they begin to feel the full effects of their dilemma. This realization occurs well down the line from when the problem started, but the extent of their problem rapidly becomes apparent, and they suddenly seem to collapse.
Here’s the message in the numbers: Any company can outlast a recession, if its products are solid, its customers are satisfied, and its cash resources and borrowing capacity are adequate. In today’s competitive market, if any one of these is not up to snuff, the company could be in trouble in a decline, and not know it until it’s too late. If two or more are inadequate, its survival may be in serious doubt.
If your cash flow needs some positive assistance, or your need help in growing your practice, call LawBiz® (800) 837-5880 for assistance.
