Cash is king

Excerpt reprinted with permission from The Credit Crunch: a Practical Guide, Grant Thornton LLP, 2008


What’s the issue?

Cash is the lifeblood of any business and matters more than earnings. As the saying goes, “profits are an opinion, but cash is a fact.” More and more, bankers, investors and advisory professionals focus on the often ignored cash flow statement. If earnings are growing faster than cash flows, red flags are raised.

In a slowing economy, understanding and managing cash flow is of paramount importance. Customers are likely to pay their bills more slowly, sales and profitability will likely diminish, and banks are less inclined to lend against insufficient or aging collateral. Liquidity can become constrained very rapidly. In recent history, many businesses didn’t keep a close eye on their cash flows or near-term liquidity because it wasn’t necessary. Banks were happy to step in and fill funding gaps.

What can you do?

“Undertake a critical analysis of your business operations and understand the resulting impact on liquidity. Focus on the components of working capital and the cash conversion cycle. Build and conserve cash. In a financially distressed business, build a war chest of cash, even at the expense of drawing down on interest bearing credit facilities. Forecast near-term cash receipts and cash disbursements based on realistic financial projections and a sound starting point and include an analysis of the impact of those assumptions on your borrowing base. Analyze variances and learn from them. If you can’t produce this from information you have, bring in outside help. You need to look beyond sales and expenses and focus on actual cash, not profits or EBITDA,” suggests Gord McFarlane, Managing Partner, National Specialist Advisory Services.

Negotiate aggressive credit terms with suppliers and customers. As soon as invoices are late, begin subtle but firm collection efforts. If customers believe they can use you to finance their own cash needs, they will. Reduce inventory levels and replenish on a just-in-time basis, to the extent practical. Sell aged inventory. In the short-term, it may be wiser to sacrifice profitability in order to generate cash, but keep an eye on your borrowing base. Advance rates on inventory tend to be low, so focus on selling inventory to generate cash.

What to avoid?

“Remember that big is not always better,” comments Bill Brushett, National Client Services Partner, Audit and Tax Services. “Growth consumes cash. A significant sales or expansion opportunity that appears profitable on its face may have dire consequences on a company’s cash conversion cycle and its ability to finance it in this market. An increase in the duration of the cash conversion cycle is a negative signal. Thoroughly consider the implications to cash flow from increased sales requiring capital expenditures and ramp-up periods. Understand the worst-case scenario and make decisions accordingly.”