By Maurie Cashman
Sometimes the answers are simple but not obvious, particularly when the problem is something we see every day. Can you solve the following simple problem? (Note, you have 20 seconds to answer)
I often come across problems like this when performing a business valuation or when beginning to work on an ownership transition plan. Things will jump out during analysis of a business that are simply not visible to the business owner. The reasons for this have nothing to do with knowledge of the business. The reason has to do with having a wide variety of experiences and a different perspective. An experienced outsider will simply observe your business in ways which you do not. Letâ€™s look at some real-life examples involving working capital as a place I have often found issues to address.
|â€œWhat you have to do and the way you have to do it is incredibly simple. Whether you are willing to do it, that’s another matter.â€|
management consultant and writer
Too Much Cash
Having too much cash on hand seems on the surface to not be a problem. Who wouldnâ€™t want too much cash lying around? This problem is commonly seen in very healthy businesses. I have worked with businesses with over a million dollars in cash with no plan to deploy it, and it can create issues.
The issue arises most commonly in a business that has very little debt. The business is throwing off a lot of cash and it builds up inside the company if it is not re-invested. In many, but not all, cases this indicates a business that is being run as a â€œcash cowâ€. A cash cow is a business that generates a lot of cash for the owner but is likely not in a growth industry, so there are not good investments the business can make internally, like equipment, logistics, R&D.
The issue seems to be that it provides the owner with a huge level of security in knowing that there is always plenty of cash to meet any need. Some owners cite seasonality as a reason. Even when I work with highly seasonal businesses, they are perfectly capable of utilizing an operating line and paying it off every year. Oftentimes when I point out this â€œexcessâ€ cash, the owner is surprised. They have simply become accustomed to it and havenâ€™t given it a thought. Some have a deep aversion to any kind of debt stemming from the startup of the business or to family attitudes.
So whatâ€™s the problem with too much cash and how can it be looked at differently?
- Cash on a balance sheet invites lawsuits. The first two questions an attorney is going to ask if you are ever sued are â€œCan you please provide us with your insurance policy; and, Can you please provide us with your financial statement?â€ You shouldnâ€™t need to ask why.
- That excess cash could be distributed to shareholders to reinvest, used to purchase the building you are leasing, invested in an ownership transition plan or used to purchase a competitor.
- You could be creating a shareholder-driven problem for the business. Your shareholders have a claim to that cash. If you want to buy out your partner, you are going to have to pay out that partnerâ€™s share of cash, forcing you to acquire an operating line. It may be easier to do that now and have it in place when you want to purchase the company stock from your partner.
Too Much Inventory
Having a lot of inventory is similar to having a lot of cash. It creates a level of security for many business owners. This is most often seen in distribution and retail businesses and can have multiple causes.
I have worked with a few extreme examples of this.
The first was a high-tech equipment distributor. The company prided itself on its level of service and on being the â€œgo-toâ€ place for hard to find items. It was the sole distributor, or one of two, in North America for several global companies. The company bid and won a contract to provide all of the equipment to install a communication network for a large city in the SW United States. After taking delivery of the equipment, the economy crashed and the city canceled the project. The general contractor refused delivery of the equipment and the manufacturer refused to take it back. So we are stuck with a large amount of specialized equipment. A problem, but one that we could work off by selling the inventory over the next few years.
Unforeseen Event: The manufacturer upgraded the product from 2.0 to 3.0 and then sold themselves to a company in India, which promptly discontinued support for the 2.0 model. 20% of our inventory was immediately obsolete and we had a purchase offer for the company on the table. Scramble time.
A different view of this problem may have been to be much more aggressive with the city, general and manufacturer to work together to resolve this issue, rather than assuming that the inventory could be sold in a few years in the ordinary course of business.
This problem is often seen in smaller wholesalers and retailers. These businesses often hold themselves out to be the place to go for that hard-to-find item. They see it as a competitive advantage. If you want to buy a particular style of boot that hasnâ€™t been made in 30 years, I can tell you where to find it new in the box.
There is a reason outlet malls exist. It is not because customers demand them. It is because savvy companies realize that dead inventory must be turned into cash as fast as possible.
These are just a couple of examples. There are many more. The issues are deeper than simply accounting problems. When is the last time you got an outside perspective of your business from someone with deep experiences and a different perspective than your own? Their ability to see the simple but not obvious may save you a million.
Check in next week for the answer to the problem.