HEALTHY CASH FLOW – THE SECRET TO BUSINESS RESILIENCE

The seemingly simple concept of managing positive cash flow trips up all too many business leaders. You must have enough cash on hand to pay your bills, invest in research, develop new products, build efficient plants and so on. Companies with strong balance sheets are resilient and can take advantage of growth opportunities. Those that are too leveraged—too much debt and too little cash—are vulnerable anytime the economy shifts and are unable to react swiftly to crises that arrive.

A perfect example of the benefit of maintaining positive cash flow is Johnson & Johnson’s response to the 1982 Tylenol scare. In a period of a few days, seven people in the Chicago area died after taking Tylenol capsules that were laced with cyanide. At the time, Tylenol was one of the leading pain killers on the market, accounting for roughly 17% of J&J sales. This was not only a public safety crisis but also a public relations nightmare for the company.

James Burke, J&J chairman, made the bold decision to quickly pull all Tylenol product off the shelves in a global recall. Rehak quotes Albert Tortorella, an executive with PR firm Burson-Marsteller, “Before 1982, nobody ever recalled anything. Companies often fiddle while Rome burns.”

Burke’s decision was not insignificant. The recall and subsequent relaunch cost well over a $100 million.

Resilient organizations need strong leadership, but they also need the capital to respond to rapidly unfolding events. Burke was able to make what is now regarded as one of the best business decisions in the last 50 years because his company could absorb the costs. Resiliency is not just having an umbrella on a rainy day; it’s also the ability to quickly take advantage of emerging trends or changes in the market. Think of Apple’s ability to continually innovate and offer new products and services. Or Netflix’s transformation from a DVD subscription service to a leader in streaming content.

Being resilient requires healthy cash flow. Let’s now look at two attributes that help strengthen resiliency:

• Recognition that cash is as important as revenue
• Understanding that there is a big difference between operating cash flow and balance sheet window dressing

CASH VS. REVENUE 

Revenue is important, yet there is far too often a fixation on revenue alone. There are many examples of companies that get stuck when markets change, and they simply can’t adjust because they don’t have the resources (cash) to make necessary investments.

As just noted, Netflix reinvented itself from a DVD by mail business into an entertainment behemoth. By contrast, Blockbuster, once a mighty video rental chain, is now just a distant memory. In an interesting twist of fate, Marc Randolph and Reed Hastings, cofounders of Netflix offered to sell their fledgling company to Blockbuster for $50 million in 2000, only to be rebuffed because Blockbuster management thought the price was too rich. In 2023 Netflix was worth more than $150 billion. Blockbuster could not react quickly enough to changing technology and customer preferences. Lacking the liquidity to adapt, it filed for bankruptcy in 2010 and by 2014 it closed all its company-owned stores. Strong revenue is not enough to become resilient. It takes cash.

Resilient organizations are quick to adapt. They have the resources and the culture that enables them to respond to downturns and to capitalize on changing market dynamics.

I coauthored a study at Ernst and Young in 2022 that demonstrates a strong correlation between effective cash management and resiliency. We reviewed 5,000 global companies and evaluated how well they manage working capital. The upper half of those companies are 20+% more effective at limiting the initial shocks of market downturns. Further, weaker performing peers in the bottom half spend on average 26% more time after economic downturns lagging peers in terms of shareholder return. It takes cash to address market shocks.

When global supply chains collapsed at the onset of the pandemic, companies scrambled to adjust, investing heavily to secure materials and paying far more for logistics. Some used debt to fund their capital requirements. This worked as long as interest rates were low and the cost of debt was cheap. But, as the economy heated up and inflationary concerns were addressed through rising interest rates, the debt strategy became unsustainable. Organizations that entered this period with effective cash management discipline not only were better able to respond to market shocks but also they used their strong balance sheets to win market share from weaker rivals.

The market is never constant. There are always ups and downs. Smart leaders recognize this and are focused on cash management at all times. I refer to this as having a cash culture. A company with a cash culture understands it is not just about revenue growth but also about cash generation. This is not as easy as it sounds.

Most businesses are built on a profit-and-loss (P&L) culture where sales rule. But things can get out of control very fast. For example, salespeople can agree to all sorts of terms and conditions. You won a big deal but can’t get paid for 120 days. Purchasing can chase the lowest cost for material but in doing so agree to large quantities with long lead times. Manufacturing can operate plants most efficiently through long run cycles—running equipment at capacity, but your investment in inventory balloons. There are many examples of trade-offs management needs to make to keep equilibrium between the P&L and the balance sheet. Unfortunately, many of the decision rights for those trade-offs are scattered about the organization and are being made by individuals without insight into downstream effects.

Companies that truly have a cash culture ensure that people have the right tools and training to make good decisions. They promote processes and policies that improve cash generation. And they align incentives and metrics to ensure compliance and sustainability.

NOT JUST WINDOW DRESSING 

There is a big difference between actual operating cash flow health and window dressing. Because the balance sheet for public companies is reported only on a quarterly basis, it’s a snapshot at a point in time. Holding back payments to vendors or temporarily delaying inventory shipments is the equivalent of airbrushing the results. What matters is average daily cash balances. That’s cash that can be used to invest in new equipment, pay down debt, and pursue new markets and acquisitions.

Revenue is important, but so is cash. Unfortunately, far too many businesses either don’t fully appreciate this or they lose sight of the basics as they grow, and they only chase revenue. Don’t get caught short, when your  company most needs cash and a truly healthy balance sheet. It can cause you to come up short and will take you longer than needed to bounce back from the setback or emergency.

Written by Peter Kingma.

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