Strategy

31st July 2014

Danger! There is a Recovery Ahead

Hi,

Team Massive Result’s Thursday’s Thoughts

Please enjoy “Danger There Is A Recovery Ahead” by Ian Kinnery

The pundits are full of backslapping celebrations that one of the deepest, longest and most devastating recessions in history is either at an end or coming to an end and the UK seems to be leading the pack on this road to recovery.

Whilst this might seem to be great news and most welcome don’t be fooled. There are at least two notable dangers when a period of economic recession comes to an end.

Historically more businesses go out of business as we come out of a recession than going into one.

Why? Well as we go into a recession businesses can reduce costs by tightening their belt, buying less, negotiating harder and even by losing headcount. If they react quickly enough they can survive a downturn in trade. It has always been the case that businesses can last a lot longer without making a profit than they can last without cash, and as sales reduce cashflow is not immediately so effected. Cashflow tends to lag behind sales, particularly when a lot of sales are made and credit given. Often the cash inflow at month three of a downturn still relates to a sales performance three months earlier.

As we go through a recession firms have often generated cash by selling down stock, calling in all of their debtors and stretching their creditors. They survive the recession by being especially lean, with no fat on their back.

Of course as we come out of the recession and sales pick up, so our purchases of stock and raw materials need to start to increase.

This brings a cashflow pressure that can be impossible to meet. We need to find more and more cash to fund our increasing sales, but with no fat on our backs and that lag caused by the period of credit that we have given our customers. It can be very difficult to fund that growth.

Historically we may have been able to turn to our bank and argue the case for an increased overdraft to fund the growth.

In 2014 that may not any longer be possible. Banks have clearly and repeatedly demonstrated their reluctance to help businesses over the last few years and that doesn’t show any signs of changing now.

So attention to cashflow may be of even more import in the next few months as it was in the darkest days of the recession.

The only certain way to fund growth is to be self funding which means generating enough profitability to keep the generation of cash and the consumption of cash in balance.