Vol 1 (2004) - Issue 1

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Companies Must Think Strategically about Cash Management

The recent downturn in corporate fortunes is giving rise to liquidity problems across a wide range of companies. Although management teams are having to address these problems to ensure the survival of their businesses, they do so at their peril if they pay insufficient attention to the longer term consequences of focusing exclusively on cash. By managing through cash, managers can balance the need to think strategically about the future of the business while still retaining cash management as a central objective.
Stock markets have come down with a bump. During the halcyon days of the 1990s the link between share prices and underlying financial performance was stretched to breaking point. So much so that in certain sectors (particularly internet businesses) there was talk of a ‘paradigm shift’ which seemed to imply that the relationship between enterprise value and performance was irrelevant. Indeed, it was almost a badge of honour, and indicative of a commendable confidence on the part of management to invest in the future, for companies to spend extravagantly even when revenue was negligible.
In the more sober economic environment that now prevails, traditional measures of value have reasserted themselves. It is a reflection of how far removed from reality the markets had become that they have fallen so far in recent months. By historic standards, they are not undervalued even now. This is because they are once more looking at cash generation as the key measure of fitness to survive and are punishing companies that fail to earn a sufficient cash return.

Managing for cash

How are managers to respond to this situation? The obvious answer is for them to concentrate on cash, if necessary to the exclusion of almost any other consideration. In this way, the argument goes, many of their problems, even the seemingly intractable ones, stand a good chance of being solved. Investors and bankers are keen to support them in this endeavour. The terms of a refinancing following a cash crisis are likely to be very restrictive. Banks will be watching closely and off-plan performance is likely to lead to early covenant breaches. In this environment, cash can easily become the be all and end all.
As a result, CEOs and CFOs are currently rolling up their sleeves and putting themselves through crash courses in how to manage for cash. They are learning to draw up accurate short term daily rolling cash forecasts, to develop responsive mechanisms for prioritising financial commitments, and to manage unforeseen events through the use of contingency plans. They are axing capital investment, laying off the workforce and offloading assets and investments that they feel they can live without. This behaviour is exemplified by the current crop of share buy-backs, where managers in such industries as pharmaceuticals are distributing surplus cash to shareholders rather than re-investing it in the business.
However, this approach has its dangers. While it may appease bankers and analysts, it is likely to be a short term solution. The act of focusing on the generation of cash today can lead to the starvation of the mechanism that will generate cash tomorrow. If any investment that has no immediate benefit is cut, the essential process of business renewal and the creation of future value grinds to a halt.

Managing through cash

No management team can successfully run a business for ever by focusing only on the short term cash position. At some point, it must think strategically about the future. The question is how to do this without losing sight of cash. Successful managers adopt a formula that can be described as managing through, rather than for, cash. While managing for cash makes day to day cash control the key objective of the company, managing through cash makes the long term success of the company the key objective but in a way that is consistent with the need to manage the cash consequences. Cash therefore ceases to be solely a short term tactical concern and takes on a strategic significance.
Managing through cash involves a number of things. It involves understanding the precise linkage between revenue and cash and continuing to prioritise how surplus cash can be used to drive out greater savings later. For example, rather than repay bank loans, cash might better be used to refrain existing staff to work more flexibly or pay for capital expenditure with an early payback.