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In sickness and in health

Good cash management is arguably more imperative to company success in an upturn that in a downturn. So make sure it stays on the agenda even though things are getting better writes Walter Hale, our business knowledge expert.

Cash isn’t king, it’s God. V. Balakrishnan, the chief financial officer of Indian outsourcing giant Infosys, never forgets that mantra. His philosophy: “Run your company in good times as you would in bad times”. That doesn’t mean refusing to invest in the business as a strange kind of recovery finally gathers momentum but it does mean never losing sight of the fact that if you’re out of liquidity, you are dead.

The need to manage cash more effectively hasn’t gone away just because the UK economy may grow by 1.7% this year. Every adventurous company is now exploring how they can grow turnover, market share and profitability but these laudable objectives should not be achieved at the expense of sound cash management. The old cliché that turnover is vanity, and cash is sanity, still holds true.

The economic turmoil drove many firms back to basics. They have become much better at cash forecasting. Monthly cashflow forecasts have enabled finance directors to take a view over the whole business cycle – from conversion of raw materials to the delivery of product and the payment of cash – and act accordingly.

Few businesses have mastered this black art so completely their forecasts are perfect but by clearing the process of internal politics, making managers accountable for the accuracy of their forecasts, and keeping the rules as simple as possible they can reduce the margin of error. The era of virtually unlimited, cheap credit for business is over. For this stage of the business cycle – which could last five or ten years – firms that manage and generate cash effectively will have a serious advantage over their rivals.

When a private equity firm buys a company, they spend the first 100 days analysing how much cash they can generate without hurting the business. That kind of review – conducted at least once a year – may become as familiar a corporate ritual as the budgeting process.

Most managing directors believe they are much better at managing cashflow today. And yet All Tied Up, a 2010 report by accounting giant Ernst and Young suggests there is still more work to be done. Its report estimates that the top 1000 European companies have £189-353billion of working capital unnecessarily tied up, a giant sum which equates to 4-7% of turnover. So Ernst and Young says companies need to take “a structured ‘root and branch’ approach to improving working capital”, exploring such options as working even more closely with key customers and suppliers, driving ever greater efficiency out of the supply chain and setting up dedicated teams to focus on the issue.

That sounds like so much rhetoric, but it could translate into such specific action as saving money by using fewer suppliers, making sure you get paid sooner by improving the accuracy of your invoices or even – and astonishingly, despite the recent emphasis on destocking, bad debts and payment terms, only one in three firms do this – linking cashflow to management incentives.

Realistic cashflow forecasts are especially important when you enter a new sector or invest in new kinds of technology. Jim Cohen, executive vice-president of mergers and acquisitions at the American print group Consolidated Graphics, noted recently that companies moving into digital printing were often unpleasantly surprised by the cost: “To compete, you need multiple digital presses. And these presses need constant upgrades like your laptops so printers may find themselves spending more on digital than offset. This isn’t intuitive to owners because the initial investment is typically less than for an offset press. But layer on click charges, down time, software upgrades, and the rapid evolution of digital technology and you’re going to need a lot of capital to compete in the digital arena.”

Yet there are companies, with a strong reputation, a growing market niche and specialist technical expertise, which are already generating a lot of cash. The challenge for them is to think twice about they invest it. Multi-billionaire Warren Buffett knows as much about cash management as Albert Einstein did about the theory of relativity and he has warned: “Often it’s a mistake to invest money where you’ve earned it. Truly great businesses, earning huge returns on tangible assets, can’t reinvest a lot of their earnings internally at high rates of return for an extended period.”

Whatever particular challenge you face when managing cash, now is not the time to take your eye off the ball. It’s often forgotten that businesses consume cash far faster in an upturn than they do in a downturn.

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