Why Cash is King

It is quite possible to be a fast-growing, profitable company and still end up insolvent; however, it is rare to find a company that is well-managed with an eye towards cash-flow and working capital to wind up in that position.

It has been a long-standing mantra that private firms should be managed for cash, but more and more savvy public firms (and investors) are bench-marking using “Free Cash Flow” as a metric. Simply put, this is cash flow from operations found on your Cash Flow Statement in your financials minus capital expenditures. Looking only at an Income Statement can mask operating deficiencies and other issues. If a company has cash left over after making needed investments, then it is probably sound. If Free Cash Flow is negative, then the business is not generating sufficient cash to be sustainable.

At no time in my 35 years of turnaround advisory has the need to manage and control cash been more critical to most manufacturing SME’s. In early June, SEWN collaborated with the Manufacturing Alliances of Bucks and Montgomery Counties, to conduct a statewide survey to gain a snapshot from CV-19 veteran business leaders. When asked how their operating cash position looked projecting to the end of June, 51% stated it was either tentative or they did not have enough.

While I am often surprised at how many companies have to guess at what their break-even is, even for those that know from a profitability standpoint what sales level they need, it is imperative now to take it a step further and know what your cash-break even is.

For most this entails merely adding back your non-cash expenses such as depreciation and amortization and subtracting your loan principal payment and any known mandatory capital expenditures from your fixed costs before applying your variable (contribution) margin.

In this crisis, similar to that of 2008, many companies saw an immediate drop in revenue. It is important as a business owner if you rely on a Line of Credit (LOC), to understand the terms of that loan. Many LOCs have a cap, say $1M, but that is merely a maximum. Often the amount available is set off of a “borrowing base,” typically your Accounts Receivable and Inventory. The lender sets an advance rate as a percentage of eligible assets and then defines what is eligible. As sales dry up, so do Accounts Receivable and likewise as others fight to conserve cash, they may age to the point where they are no longer eligible collateral to borrow against and that full $1m may not be available.

There is a lesson to be learned from those who lived through the hard times of the 1930’s and kept cash stashed in their mattresses. They understood that cash is king in the best of times but especially in the worst of times.