Surviving Illiquidity
Create internal cash when outside credit is tight.
May 2009 | by Mark Sheffert
Mark Sheffert
In last month's column, I wrote about the current credit crisis and why banks are lending only to the most creditworthy businesses. The logical follow-up question is: "If I can't get credit from my bank, what can I do to generate internal liquidity to survive?"
Illiquidity is the number-one issue facing businesses right now-especially small and midsize companies. Even large global companies are holding onto cash and postponing spending, because all signs point to a long, deep recession that will challenge even the most financially fit companies.
The restricted lending environment is making credit tighter, more costly, and more difficult to negotiate. Business leaders need to employ creative ways to finance their operations through internally generated cash flow.
Leverage Your Assets
In today's credit market, banks are reluctant to consider traditional cash-flow loans, but I'm observing a renewed interest in asset-based lending. This type of financing, formerly reserved for asset-intensive or less creditworthy companies, is attractive right now because it allows companies to obtain loans that are secured by various assets, including inventories, receivables, intellectual property, royalties, and in some cases, real estate. In other words, the capital locked up in your assets may be unleashed to gain liquidity, without having to pony up a bunch of new equity.
Unlike traditional cash-flow loans, asset-based loans are not dependent on existing profitability. Even companies that are experiencing distress may be able to get one of these loans because banks have the reassurance of basically owning the assets that are backing the loan. This increases the banks' opportunities to recover their losses in the event of a default. Banks are seeing more defaults now, and that's one more reason that leveraging the value represented by your assets through an asset-based loan may be a smart idea-or the only option.
Squeeze Out Cash
I can't tell you how many people say they are shocked that their business is out of cash and failing even though their profit and loss statement shows they are in the black. I am amazed at the ignorance that exists about how cash flows through a business.
To pump life into your cash-anemic business, you must get a grip on the ins and outs of cash flow and make managing it your number-one priority. Start by creating daily cash flow projections for the next two weeks, weekly projections for the next two months, and monthly projections for the next 12 months. Break your cash flow problem into little pieces, figure out where the deficits are, and find ways to improve it.
One sure way to improve cash flow is to grow revenue. Think outside the box when it comes to strengthening the top line. To protect revenues from existing customers, beef up loyalty programs, for example. Spend marketing dollars on programs to improve immediate revenues. Rethink your product mix and pricing strategies.
The most immediate way to raise revenues is to increase prices, if the market will bear it. Are there any features that can be added inexpensively to allow increased prices? Can you bundle products and services into new products, or sell extended warranties or service contracts? At the same time, you should segment customers to reveal which products appeal to customers willing to pay higher prices.
While you are focusing on the top line, don't take your eyes off of gross profit margins. Find out where your value creators and value destroyers are by evaluating margins by product category and by customer. Now is a good time to dispose of noncore businesses and assets and refocus on what your business does well. Even if business units or nonessential properties are sold below market values, those divestitures are quick ways to raise cash and improve liquidity.
One unprofitable company that we recently counseled had a growing division that management thought was profitable. However, when overhead was accurately allocated, it was discovered that the division was losing money. And when we properly priced the division's products, they couldn't be competitive. The company eliminated this division, and as a result, became profitable.
Another way to internally generate cash is to examine what's going into your cost of goods sold. Can your labor force be more productive? Are you using Lean and Six Sigma processes? Are you negotiating with vendors to get the best prices on your materials? Are you getting rid of surplus, obsolete, or impaired inventory?
Can you increase your inventory turns? If your inventory turnover happens four times a year, you have three months' worth of materials (cash) sitting on the shelf generating no return. But by turning inventory six times a year, you've reduced that to two months' worth!
Be aggressive in reducing costs and increasing efficiencies-nothing is too controversial in these times. The bright side of a difficult economy is that it forces the hard decisions that should have been made in the past. Remember, a dollar of revenue may create 10 cents of net income, but a dollar of eliminated expense creates a dollar of net income. Examine each general-ledger line for nonessential items, but don't do this alone. Ask managers and employees for ideas. Get rid of subscriptions and rented plants. Cut back on travel and entertainment expenses. Evaluate marketing and product development programs. Assess the number of employees in the company and whether you are getting value from every position. Be ruthless, creative, and innovative.
If your business is in really dire straits, cut back on employee benefits, implement a hiring freeze, and move to compensation with bonuses or company stock instead of salary increases. If you explain to your employees that this is a short-term situation necessary to save the company-and their jobs-most will go along with you.
Now is not the time to launch a new marketing campaign, start a major research and development project, or hire a direct sales force. Learn to make do with what you've got until your business has stabilized.
Finally, get more aggressive in managing your balance sheet. Focus on improving receivables collections and stretching out payables. Get as many customers as possible to pay within 30 days. Segment your customers according to credit ratings. Avoid the higher-risk customers and evaluate the trade-off of revenues from marginal sales. You may even want to consider a tiered billing program that offers a 5 to 10 percent discount for early payment.
On the flip side of the cash- management coin, hold onto your cash as long as possible when it comes to paying bills. Renegotiate terms with vendors and ask for 45- to 60-day (or even 90-day) terms. You won't be able to do this with everyone without damaging relationships or incurring late penalties, but the idea is that if you can pay your bills in 90 days and collect receivables in 30 days, you will generate two months of operating cash.
Prepare For Recovery
All these cash-focused activities, led by an executive team that is creating a sense of urgency and priority, will spread a fever of preparation and confidence among the employees at your company. Belief in the prospects for recovery is vital to survival, and it can become a self-fulfilling prophecy. Inaction is the worst reaction to an uncertain future. Even the wrong strategy executed properly can end up being more of a success than doing nothing.
The silver lining of economic downturns is the financial discipline that results. It's always good business to squeeze out internally generated cash flow, but a difficult economy makes it essential.
For businesses that do not manage cash generation, economic downturns become a time of gut-wrenching change for the worse.
For those who keep their eyes on the cash generation ball, these times are more likely to become a period of metamorphosis. The strengthened businesses that result are a whole lot prettier than the ugly caterpillars of the past.
