Monday, June 22, 2009

Cash solves all business ills; or does it?

Finally, I'm breaking through my writer's block to start my blog.... I hope you enjoy it; but more importantly, my real desire for writing the blog is to contribute, opine, share, etc., so you will contribute, opine, and share too. Thanks in advance.

My blog will share some of my and Bella Carlo's experiences and insights (however the opinions expressed herein are solely mine) so others and I can learn more from each of them. Lest not forget that as a merchant banker, we do better work and add more value to what we do when we continually learn and share that knowledge with others, especially our clients.

So onward to my first topic.... Does cash solve all business ills?

No, but let me explain, For the sake of simplicity, let's say there are two simple categories of businesses--those doing fine and growing and those hurting. In both cases cash will not solve their trials and tribulation. A good plan with proper financing will help however.

A business doing well and growing will need cash to fuel its growth and sustain its business, a.k.a.paying its bills. And lack of cash could adversely hurt a firm that has good demand for its products and/or services in that it won't be able to finance its growth and that could cause problems. However, that's a good problem to have especially if the company is well managed--i.e., a company with a game plan and a management team willing to execute the plan rigorously. A well-managed company usually can finance its cash requirements either from retained earnings and/or by borrowing against some assets, e.g., its receivables. The decision of which form of financing should be used to fuel growth comes down to identifying the opportunity costs of the available alternatives and then choosing the relatively least costly or most profitable alternative. This type of analysis would/should be in the plan.

A struggling business, on the other hand, more than likely will not benefit from just an injection of cash, even though many managers and owners attribute their problems to the lack of cash. It is usually the case that a firm's problems caused the cash shortages, not the otter way around. Examples of problems that result in cash shortages include, but not limited to, low prices on the sale of products, negative margins on each or all products sold, and/or excessive agings on receivables. If no one in the business is able/willing to change the practices/behaviors creating the problems, then no one should be surprised that no amount of cash will fix the struggling business. To the contrary, an injection of cash without a change in practices may only worsen the situation because nothing will change save the added loss of the newly introduced cash.

We encounter businesses frequently that are looking for cash as a means by which (to attempt) to solve their business problems. From our experience, and ruth be told, owners of these businesses would not know what to do with the cash if they received it. Fixing the business usually means doing somethings differently than they are/were when the problems began. We see this phenomenon way too often and, though we focus on food and agricultural, I know this happens just as often outside of agriculture. Furthermore, it happens in all types and sizes of companies--from privately held to publicly owned and from small, unknown family businesses to large, well known icons such as GM.

Bella Carlo's answer to the question is no, but a business plan and a management team committed to the execution of the plan do go a long way to solve most business ills. (I realize my statements here sound self serving, but I believe this to be true because I have lived it.). We, at Bella Carlo, spend a lot of time trying to sell the value of a detailed business plan (and not always successfully). And to this end, we cannot emphasize enough the importance of the details. It is not uncommon to see (at times written, though seldom) plans that start with pro-forma financial statements that, of course, predict profits, but cannot explain the means by which those those profits are attained. This is always suspisious. For example, if you are selling cartons of produce, but cannot articulate how many boxes need to be sold to equal the estimated total revenues, then the plan lacks the requisite details. Without details, the rest of the story that outlines the path to the promised land is just a hope. And hope is not a strategy.

Plans that lack details, especially for troubled firms, raise doubt in the most important person(s) the business is trying to recruit--the investors with cash. The reason for this is that P&L information will not tie to the balance sheet, which will then make it difficult to estimate cash flows. Without estimates for cash flows the business will be vulnerable to unforeseen issues (a common situation in all businesses) that could lead to problems. Investors know business is all about problems, but they want to understand the plans for handling the unforeseen. Each investment is about two things: generating a return and managing the risk around the investment.

This is a good place to stop. My next topic: cash is king!