Beware the hidden cost of success. After the boom years of the 1990s, more and more major corporations now are in financial trouble as the economy slows, profits disappear and revenues shrink. The executives who looked so good during the good times now face a challenge most have never seen or been trained to handle turning around a declining business. Success requires three central concepts that elude many foundering companies.
First, management must recognize that the corporation has life-threatening problems; most companies deny systemic problems until it is too late. Second, managers must have the guts to attack them; most companies take a half-hearted approach because the solution is so painful. Third, the company must know how to attack its problems. We call this “managing for cash;” executives must learn to manage for cash, not profits.
The concept of managing for cash is alien to many big-company executives. Yet, in an increasingly competitive business climate, it could save many of the 13,000 companies expected to file for protection from creditors this year under Chapter 11 of the federal bankruptcy code. The earlier a company recognizes that it is suffering long-term systemic financial problems, the easier those problems are to solve and the less drastic are the measures needed to solve them.
The cardinal rule in the turnaround business is “out of cash + out of credit = out of business.” It’s that simple, yet companies go out of business all the time because they unexpectedly run out of cash.
Why is managing for cash alien to most managers? Incentive programs at most large corporations emphasize earnings, not cash. Most managers focus on accrual accounting, which not only does not highlight, but often obscures, cash receipts and disbursements. Most executives focus on the stock price and earnings per share, not on maximizing working capital. They watch the income statement and neglect the balance sheet. Few have ever seen, let alone successfully managed through, a real financial crisis. The typical finance curriculum of business schools teaches cash management using projections of profit and loss plus or minus changes in balance sheet items. That’s close enough for healthy companies that can assume that good performance either will provide sufficient cash flow to support the needs of the business or support borrowing the needed funds. But it’s sufficiently imprecise to cause the death of many troubled companies.
Almost every company in a cash crunch gets there because sales fall, fixed costs remain high, working capital is not managed and they have too much capacity. The company misses its projections significantly, causing its lenders and the credit markets to lose confidence in the ability of management and to tighten credit terms and lower credit ratings. Unfavorable cash flow results also lead to broken promises of payments to vendors and creditors leading, in turn, to accelerated demands from the creditors, which results in an even tighter cash position. A current example is the fallout in the telecommunications sector. Missed sales projections, higher cash needs for buildout, price deterioration from overcapacity and closure of the credit markets quickly combined to throttle many telecoms.
The key to avoiding a desperate downward spiral where a weakening cash position causes creditors to tighten the screws, leaving no alternative but a Chapter 11 reorganization or a Chapter 7 liquidation is decisive and early action to cut costs sufficiently to stay ahead of declining revenues and to conserve and raise cash aggressively. The more cash, the more alternatives such as downsizing or sale of the company, are available. The earlier it is done, the less pain it will cause.
The first element of a successful plan is an accurate cash forecast based on receipts and disbursements. True cash management works by actively managing and making decisions about each of the line items of your weekly or even daily receipts and disbursements. That will save cash in the future, helping to bring costs in line with declining revenues. Selling unneeded facilities, and slow moving and obsolete inventory, will raise additional cash.
In companies in more desperate straits, it is not uncommon to sell a strategic business or facility, knowing that it may have to be repurchased in a year or two at a higher price, because the cash is needed to keep the corporation going for the next few months or even weeks. When a corporation’s short-term survival is at issue, if cash isn’t raised immediately, the corporation won’t be around to need the facility.
The dividend is one of a public corporation’s readiest sources of cash. Stopping payments on bonds and restructuring loans are two other cash-raising tools available, but they come at a dear price – defaults and credit constraints. Companies often are reluctant to slash the dividend because of corporate pride, and the fear of what shareholders and the markets will think. But what value will the stock have if the corporation is in default on its debt, or worse, out of business?
Vision is not an issue for distressed companies. The issue is stopping the hemorrhaging in the short-term. Then there will be time for strategy and vision. In all turnaround crises, if short-term problems can’t be solved, there won’t be a long term.
Most traditional companies manage to a five-year forecast. When a company is in financial trouble, its forecast should cover a few months, or even 13 weeks, and should focus on cash receipts and disbursements.
Managing for cash also means these actions:
Candidly discussing your problems with customers and vendors and requesting accelerated receipts and stretched out payables. They’ve invested in you and your products, and want you to succeed. We had one client that had completely given up on its business and asked us to shut it down because they were out of cash. It was a single-source supplier to a large manufacturing company. We convinced the customer to change from a payment policy of 90 days to “net immediate,” and our client’s business reopened.
Reducing certain maintenance items. But make sure it doesn’t affect product or service quality or cost. If you’re an airline, you had better make sure plane maintenance is first-rate. But do you really need to re-stripe the parking lot at corporate headquarters, replace the corporate jet or repaint the building this year? While these may negatively affect corporate image, a dead corporation has no image.
Cutting back on future-oriented projects. That means research and development and it means new markets. It means buying a month’s worth of materials instead of enough for the year, even though the unit price will be higher. It means selling at deep discount spare equipment and excess inventory. While these appear to be against the company’s self interest, the cost savings and cash generated may well be essential to keep the company alive in the short term.
Maintaining strength in accounting and reporting. Do not cut here. In a financial crisis, cost controls and timely, accurate financial information are critical. And the need for them increases dramatically.
Being willing to accept book losses. Closing marginal businesses and operations and selling buildings and equipment usually will result in charges anathema to the traditional manager oriented toward accrual profits. But these actions can free vast amounts of critically needed cash.
No business can operate indefinitely by focusing on the short term and cutting costs. But with today’s weakening economy, global competition and rapid technological change, financial crisis will strike more and more companies. If their executives do not manage for cash, as well as for profits, most will not survive into the long term.
Ted Stenger is a principal of Jay Alix & Associates, which specializes in corporate turnarounds, restructurings and crisis management.