Companies battled over the last five years just to maintain sales to keep their doors open. The severity and duration of the downturn damaged or shelved strategic plans for many. Now the slow – almost painful recovery dubbed the “new normal” places companies an awkward position when it comes to thinking about growth. A few have turned their complete attention to sales and productivity measures. Cost reduction programs weaken many companies by thinning management or depleting their bench strength altogether. These lean almost anorectic operations allowing business to sell on very thin gross profit margins. High unemployment not only held but pushed down salaries and benefits further decreasing labor costs. Doing more with less, allowed companies to delayed capital improvements and investments in technology. Businesses found a way to survive despite the distressed economy and the often hindrance from Washington. Businesses see strength in sales, urgency in orders and the potential for sustainable growth.
Companies today face dangerous levels of sales inequality. Geographical placement and product type have driven some firms back to prosperity while other still wait for the turnaround. The availability of credit also remain uneven as lenders try to pick the final round of loses from the recession. McKinsey reports that “the future will reveal significantly lower levels of leverage (and higher prices for risk) than we had come to expect.” Therefore, businesses that rely on borrowing will continue to suffer lower or even negative returns. As we move out of this sporadic growth business with a cohesive strategic debt structure will remain credit worthy. Those companies that find themselves in a crisis will not have the advantage of finding willing lenders. The great recession of 2007 is over but not forgotten. What may be forgotten is the transition from distress to success.
Most business owners remember higher interest rates and the struggle to make debt payments. Their bankers remember skyrocketing debt to equity leverage and falling asset values. The solution for both called for paying down loans and reducing credit lines. So who needs debt anyway? Well unless you are Google, MasterCard or Dick’s Sporting Goods, companies need debt to grow. Deleveraging balance sheets helped companies during the downturns but may have hindered their ability to ramp back up. This is the time to look at your financial data and determine if borrowing at a low rate could help long term growth.
Success: The Great Cash Killer
While sales were weak, some companies bucked the downward trend by venturing outside their comfort zone. Sustaining or even growing the topline of the income statement came at the expense of their gross profit margins. As mentioned above the deleveraging of their balance sheet and improved efficiencies in production allowed for these sacrifices in profits in the short term. The music stopped for these companies when sales growth stressed production resources to require added expenditures. At first these companies found cash in all the wrong places by using their trade payable as their bank. A few extra days delaying payments to suppliers gave needed cash flow to fund new business. When that well ran dry the next step was to tap easy money of credit cards and term bank loans. Cash for production growth was finally diverted from the payment of taxes, insurance or lease payments. These companies were clearly in the downward spiral of distress… growth at all costs.
Wrong Debt Structure
There is a simple rule when structuring any business debt: short term debt pays short term needs and long term debt pays for capital expansion or acquisitions. As for the companies above that used term loans to pay off suppliers, most found that this was only a temporary fix. Many companies using this mix term debt structure look at a due date months in the future as an opportunity to sell their way out of the cash problem.
Credit card debt to pay for supplier or equipment is the great slippery slope. Credit cards can be a valuable financing option if all you are doing is running up frequent user points and then paying it off when the bill arrives. The interest cost on credit cards can quickly eat into even strong gross profit margins. Should a company experience weakening gross margins to attract great sales, the carrying cost of credit cards may suddenly become unsustainable.
Finally, support growth by “stretching” your payables rarely works beyond a few months. Eventually, the suppliers no longer are willing to carry the debt. In the worst case scenario it only takes one large supplier to place a company on COD starting the domino effect that brings down the company’s cash juggling act.
Building a Better Plan
As the economy improves and success begins to stress resources, best practices call for companies to revisit their strategic plan. If you don’t have a plan because the last 5 years were uncharted waters, it’s time to start building a company financial plan.
- Understanding who generates your gross profit margin. Not all customers are alike. Some buyer have done a good job of holding down your prices, so they no longer are the lucrative customer from the past. Look at your cost associated with major projects and determine if you are still making a fair profit. In some cases it may be time to increase prices at the risk of losing low margin business. The buyers that “kept the lights on” 3 years ago may be hindering your company from growing in the future.
- Monitor your cash flow. Build a 90 day cash flow template that lets you see the sources and uses of cash over the next 90 days.
- Calculate your cash conversion cycle – Inventory > Sales > Receivables > Payables > Purchases > Inventory…
- Build a 1 year budget or dust off that old budget that has not been updated.
- Determine what would happen to the balance sheet if your sales took an upward spike.
- Holding more inventory
- Higher levels of Accounts Receivable
- Purchasing new equipment
- Updating technology
- Inventory and A/R – revolving credit line
- Fixed Assets – term loans or leases
- Property – mortgages
- SBA loan guarantees
- USDA loan guarantees
- FCEDC Revolving Loan Funds
There is no argument that planning for growth and having good cash flow tracking is the best method to prepare for what lies beyond the recession. Your CFO or accounting department may need additional resources from an accounting firm. Other low-cost options are to engage development organizations such as FCEDC or UW-SBDC. These organizations have seasoned business professionals that have helped other firms grow their top lines while monitoring the bottom line: A partner in planning to allow you to weather the vulnerabilities of success.