Dreaded Death Spiral– Negative Cash, Cash Flow: Revenue is Vanity, Cash Flow is Sanity, Cash is King…

Cash may be king, but cash flow is the power behind the throne… Avoid the death spiral pattern: Low cash leads to increased borrowing, leads to increased interest, leads to lower profits, leads to lower retained earnings, leads to higher liabilities, leads to increased current liabilities, leads to  even lower cash flow— it can become death spiral.

Cash is life-blood of  a business, but cash flow is the most important focus– no business can survive without enough cash to meet its immediate needs, and cash flow is the source of that cash in a sustainable business… An unprofitable business can survive if it has cash, but a profitable business will fail if it runs out of cash to pay liabilities…

cash thMHHAWI9H

According to Angela Armstrong; cash is the new ‘purple’, it confers; liquidity, agility, power… a great example is the dominoes effect of Wall Street investment banks during the recent recession… The collapse of liquidity in several of the Wall Street investment banks cascaded into others, and just about toppling the whole industry… While it’s not easy to draw direct comparison between large capital markets and private enterprise, one thing is sure; cash is defiantly king– purple robes be damned– too little cash at exactly wrong time can kill a business, or even a whole industry… Lack of cash is one of the top three reasons that organizations fail…

In the article Cash Flow as Measure of Performance by Maxwell Samuel Amuzu writes: Cash flow is one of the most important measurements used to value a business– it provides a clearer picture of what the company is truly doing… The study of cash flow gained prominence as early as 1966, following studies by H. W. Beaver. His studies indicated that cash flow as a function of total debt was an effective way of forecasting the failure rate of a business… Also, it’s important to note that cash flows are generally ‘objective’ in nature and, as such, no value judgment exists as to how and when revenues may have been recognized… Cash flow statement recognizes the exact amount of cash that is either pass; out of, or into– an organization… In other words– profit is opinion; cash is fact…

cash thDMAXO3M4

In the article Value of Cash by Hans Tallis writes: How much is $1 of surplus balance-sheet cash worth? Less as a company matures, it turns out… Several research studies have examined the relationship between balance-sheet cash (i.e.; cash, cash equivalents that appear on firms balance sheet) and market capitalization… A study suggest that investors value incremental balance sheet dollars between $0.23 – $1.80. The different valuations are explained by characteristics of organizations, e.g.; cash is worth more to companies,  in the following situations:

  • Investment options: Companies trying to develop a new technology, business model… in rapidly changing or consolidating sector(s)…
  • Unprofitable: Companies whose margins are too thin to generate sufficient retained earnings…
  • Limited or expensive access to external capital: Companies without a readily available source of liquidity…

In contrast, cash is worth less to companies that can be described as the following:

  • High credit quality: Companies perceived as investment-grade and have unfettered access to external capital…
  • Stable growers: Companies that have smooth, predictable investment needs and whose earnings comfortably cover those needs…
  • Over-stressed: Companies that use surplus liquidity is to pay down debt…

A clear understanding of both the benefits and costs of additional balance-sheet cash helps guide decision-making about appropriate levels of liquidity… In some case it’s may be best to simply return surplus cash to investors in the form of dividends… or, if it’s ‘cash trapped’ offshore (cash that firms earned overseas but, usually for tax reasons, they delay its return to their country of origin)– then it might be better to repatriate and distribute the cash, even if it costs upwards of 35% in tax leakage to do so… or, invest cash in highly competitive ‘moonshot’ project… or, if there is M&A opportunity that may be the best use of cash… or, it might be better to hold on to cash and take advantage of low debt costs to enhance financial flexibility…

cash thM1U2DC5L

In the article Business’ Most Important Asset by Gene Marks writes: There is no clean definition for what constitutes sufficient cash liquidity. According to Ross Crane; firm is liquid when it has ability to continually fund business in variety of ways, e.g.; company’s liquidity can change immediately by something as simple as one large customer missing a payment or filing bankruptcy. Companies need variety of funding sources: cash, equity, lines of credit, debt… having a cash cushion is about ensuring short-term survival

According to Gary Harpst; keep (or have ready access to) enough liquid assets (i.e., cash and cash equivalents) to fund short-time obligations, and that allows adequate time to arrange financing or lower expenses… one way to determine the amount of cash cushion a firm might need is by comparing amount of time it takes to collect; cash, or receivables, or secure a loan, or negotiate equity arrangement… vs. lead time needed to pay near-term obligations without going default… The life-span of ‘working-capital’ accounts dictates how much grease is needed to keep gears turning on a short-term basis…

Bankers and investors don’t like surprises, and neither should you… If you think revenue are ebbing, or margins shrinking, or expenses increasing… then adjust, quickly. Having greater foresight, provides more time for triage, more credibility for options… Managing cash doesn’t mean stuffing it under a mattress– it means making sure there is enough available to keep playing through the hard times… once you run out cash there are no good options…

One of the classic sayings in business and it’s also one of the great truths– ‘cash is king’… Cash presents business with many opportunities, e.g.; it’s the ultimate reward for business success, it’s an opportunity to make additional investments, it’s security for an unknown future… However, it’s important to appreciate, understand that cash is not something that ‘just happens’…  Cash is ultimate symptom of an organization– it’s the lagging indicator of business performance. Cash is either; realized or not realized, but only after series of related events, e.g.; successful execution of well-conceived, strategic business plan… which primes the pipeline for the flow of cash for the organization… 

cash images8TWWAHL5

According to John R. Curry, Lyn Hutton; effective cash management is crucial component of enterprise risk management… it’s the ability to access cash as needed, or  easily convert business assets to cash as needed… but managing cash and liquidity have risks that lurk around nearly every corner… Although a focus on liquidity is crucial, it’s also important to note that business must not lose sight of the its strategic objectives… Cash hoarding, or focusing singularly on minimizing risks incurs opportunity costs, which can lead to critical ‘shortfall’, i.e.; failure to meet business objectives…

Thus while there are costs for ‘too little’ liquidity (cash), there are also costs for ‘too much’ liquidity. Thinking ‘out-of-the box’ and asking speculative questions can enhance choices… The key is finding the right balance between; cash, cash flow, liquidity… and strategic and operational performance… the best time to think about business liquidity (cash) is when it’s not an issue, when it’s not a priority…

It’s like chess; when opponent captures the king (cash) then the game is over… when they captures the queen (cash flow)– it’s beginning of the end of the game… Hence, protect ‘cash’ and use it wisely; energize ‘cash flow’ with creative strategic initiatives…