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Purple Cash Cows (and other business truths)

By Angela Armstrong – May 23rd, 2013 – 5 comments

Like any great leader, you’ve battled your way to the top. As Caesar Augustus, you’d return from a 20 year campaign to a life of glorious excess (and a little political intrigue), garbed in Tyrian purple robes.

Purple has long denoted wealth in human society. Laboriously created by harvesting the organic ink of thousands of mollusks or sea snails, drop by drop, and therefore astronomically expensive, it was exclusive to the Emperor in 4 BC.

Fast forward to 1560AD — even Queen Elizabeth I forbade the wearing of purple by any but those whose address boasted a moat.

Unless you’re a Fashion Week aficionado, real power in 21st century society no longer rests in the turn of your coat. Instead, it exists in economies that boast buying power. Maybe Elizabeth saw it coming – in the Age of Exploration, monarchs aggressively invested in risk-taking adventurers (latter day entrepreneurs) to grow their empires and secure critical new resources to gain advantage and secure money to shore up throne and fleet. Like those long-ago voyages, modern business is a delicate balance between risk-taking and pragmatism. Like those long-ago monarchies, businesses require an ample supply of free cash flow.

Cash is the new purple. It confers liquidity, agility, and power. If you don’t think that’s true – look at the toppling dominoes of Wall Street investment banks in 2007-08, each depending on both market confidence and the ability to meet margin calls with real liquidity, to lever assets and trade. As a result of a market-driven overnight collapse of liquidity, of the big 5 Wall Street investment banks operating in 2007 only 2 remain today. Wall Street, and the global financial markets, are forever changed. (Cyprus)

While not easy to draw direct comparison between large capital markets and private enterprise, one thing is sure; Cash is still defiantly King, purple robes be damned.

Cash is critical, and in having it, timing is everything. One of our very successful clients reflected on the early days of his business growth. His bank called each morning to ask what his deposit would be and he’d audibly riffle phone messages off his desk implying they were cheques. After hanging up, he spent hours dialing for dollars collecting receivables to make an honest man of himself. There were some tense moments, he says –he’ll never forget how close he came to simply not surviving. He was persistent, AND lucky.

Too little cash – at exactly the wrong times – can kill you. Lenders obsessively calculate and ruminate on cash flow statistics in order to decide how, when and to whom they will lend cash. Skeptical? Google business cash flow – more than 45 million possible responses on cash flow and liquidity. LACK of it is one of the top three reasons that businesses fail.

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Even in 2013, Cash is Queen. And STILL purple.

In Feb 2012, Amazon was the subject of concerned analysts. The topic: its free cash flow. Analysts worried that Amazon’s profitability was strained. In January 2013 Jeff Bezos defended Amazon’s new business strategy in spite of lower margins. “It’s the absolute dollar free cash flow per share that you want to maximize. If you can do that by lowering margins, we would do that. Free cash flow, that’s something investors can spend.” Bezos and the analysts naturally have differing opinions about the value of this metric in measuring Amazon’s market recovery. What matters is that they’re having the conversation at all – and cash flow is at the centre of it.

Here are the statistics: 1/3 of businesses at any point in time are experiencing cash flow issues. As it was for Wall Street, liquidity is critical to business . (And these are not the kind of liquid assets that my brother- in-law has in his well-appointed wine cellar.) Cash flow problems are easy to detect. Slowing payables, erratic inventory purchases, closed locations or laid-off staff are easy markers. More than half of companies with money challenges blame slow payments from their customers as the reason for their own cash flow issues.

Every business is a customer of many others. If YOUR receivables slow to a glacial rate, and you`re churning the dollars out as fast as they come in, your churn rate just took a big iceberg to the teeth. Suddenly, being called “Titanic” has a whole new meaning.

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Some companies have had to rely on very expensive short term loans to bridge cash flow gaps. David Barker , CTO and Young Entrepreneur of the Year for 4D Data Centres, commented in an interview with Real Business in October 2012:

“for two consecutive months we had to take a short term loan from our majority shareholder to pay our suppliers, which meant that we had a potential cash flow crisis….The problem was that some of our clients, particularly the larger ones, were delaying payment beyond our invoice due date – effectively, using us as a cheap source of credit.” (PS Crisis financing is always expensive.)

And receivables aren’t the only culprit. Even if your clients pay you early every month, hiring staff, investing in equipment and technology, or acquiring competitors, takes capital. Unless your business has the Midas touch (lucky you!) you’re borrowing from current operational cash flow against future growth.

Home-owners know that they can’t eat doorknobs. Business owners can’t eat too much inventory, excess production capacity, or new locations with no new growth – all statistically causal factors when businesses hit the wall. And even experienced captains of industry can’t always react quickly enough when the market exuberantly throws a tsunami their way.

Private enterprises also suffer Wall Street- like pain. A large rental company we deal with experienced difficulty when their overseas Spanish suppliers hit trouble in 2010 – creating the need for expensive short term arrangements with alternative domestic suppliers. External volatility out of their control put pressure on the value of the security collateral held by their bank, and impacted their ability to borrow against those compressed assets. Put another way – that call from the bank asking what other assets they had to pledge to shore up leverage, was a really bad way to start the day.

Like it or not, whether you’re a large pubco or a private enterprise, someone’s monitoring your liquidity. What those equity partners, lenders, or institutional shareholders love to see? You, being a cash cow – meaning you are squarely in the purple.

In the public markets, the definition of a cash cow is a company which will have plenty of free cash available after paying its necessary yearly expenses. The value of cash is clear –

  1. Free cash can be reinvested to grow a business.
  2. Cash provides a cushion for emergent, unforeseen needs.
  3. It can also be paid out to shareholders – requiring little extra effort from those shareholders (who are happier getting dividends than a call for more cash) in order to continue conveying returns and growth.

If your business is capital asset intensive, you’re continually balancing the need to invest, with the need to create a return on that investment. Tough to have your proverbial cake and eat it too, huh?

Again, timing is everything.

Value investors look for companies whose free cash flow equals more than 10% of sales revenue. Free cash flow is calculated by deducting annual capital expenditures from annual operational cash flow.

Property, plant and equipment (PPE) expenses can suck up cash flow with the efficient voracity of a Dyson vacuum cleaner. And the return on their implementation can be long, arduous and uncertain. With all that, what’s a business owner to do? Unlike Monarchs of old who had the ability to levy taxes to improve the state of their Treasury, most enterprises control sales and expenses.

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Instead of using your irreplaceable current cash cushion to buy capital assets, why not pay for them over time, through the growth of the business. It’s a great way to maximize ROA. Strategically matched asset-backed financing is the business equivalent of expedition insurance for those early ocean explorers.

In Canada there is ample access to complementary sources of capital that use fixed assets as collateral against a matched, strategically defined and timed financial instrument.

A controlled amount of third party asset financing gives you power over your short term capital outlays (and therefore important key financial ratios used by banks to calculate leverage capacity). It also offers diversification of lending – and conservation of that incredibly important asset – your cash on hand. Accessing functional finance solutions such as capital equipment leasing could keep you afloat, especially in choppy waters.

Ruling an empire, or growing a business, are tricky ventures at best. Elizabeth I famously said “All my possessions for a moment of time”. How about trading those possessions for cash, which will BUY you time? It’s up to you, but if you’re clever and resourceful, you can become a cash cow, AND stay in the purple.

Purple cow image: Chris Harvey / Shutterstock.com

Comments
Antellot

I am so grateful for your blog.Really looking forward to read more. Want more.

Syam

You can point to most places in the Midwest and probbaly assure yourself that home prices will not drop. I lived in Wisconsin for 30 years and you definitely get a sense that their spending habits are dramatically different than those in Washington DC, which is close to where I live now...and it's not all about the difference in incomes between these two locales.I generally have found that in the Midwest, people are quite risk-averse. They do not trust get-rich-quick schemes and anything that sounds too good to be true. Even if an investment is legitimate, most people shy away from it because they tend to look at the risks rather than the benefits.Part of this mentality may be that they can live the way they want to, and still be conservative in their investments. It is quite affordable to buy a house with a good-sized yard. And sure, there is not much to do in the evenings or on the weekend, but most of them are not looking for that anyway. That's why they live there already. And if you're not looking for entertainment, you're not going to be spending much money either, and possibly....you may want to sit down for this part....some of them actually save money for a rainy day! What a concept!Their risk-averse nature also leads them to often want nothing for something. It is very common for houses to sit for several months without being sold. Nobody is in a big rush to get another place because they know it will always sit there for a while.There may be a few large cities in the Midwest that could be vulnerable, but I am thinking more about the smaller cities and towns. They never joined the real estate boom....it's just business as usual for real estate.

Loanemu.com

You've made some intriguing observations in your article. I am impressed with how well-written your article is and how much information you included. It just verifies that there are writers a passion for the art.

William

You can point to most places in the Midwest and pralbboy assure yourself that home prices will not drop. I lived in Wisconsin for 30 years and you definitely get a sense that their spending habits are dramatically different than those in Washington DC, which is close to where I live now...and it's not all about the difference in incomes between these two locales.I generally have found that in the Midwest, people are quite risk-averse. They do not trust get-rich-quick schemes and anything that sounds too good to be true. Even if an investment is legitimate, most people shy away from it because they tend to look at the risks rather than the benefits.Part of this mentality may be that they can live the way they want to, and still be conservative in their investments. It is quite affordable to buy a house with a good-sized yard. And sure, there is not much to do in the evenings or on the weekend, but most of them are not looking for that anyway. That's why they live there already. And if you're not looking for entertainment, you're not going to be spending much money either, and possibly....you may want to sit down for this part....some of them actually save money for a rainy day! What a concept!Their risk-averse nature also leads them to often want nothing for something. It is very common for houses to sit for several months without being sold. Nobody is in a big rush to get another place because they know it will always sit there for a while.There may be a few large cities in the Midwest that could be vulnerable, but I am thinking more about the smaller cities and towns. They never joined the real estate boom....it's just business as usual for real estate.

Aan

There may be a few large cities in the Midwest that could be vlelurabne, but I am thinking more about the smaller cities and towns. They never joined the real estate boom....it's just business as usual for real estate. - from chris g (above) WAIT, you are missing something real bigThe midwest did not get the flippers like Phoniex, but much of the middle class did refi cash out I/O ARMS to pay off credit cards and finance a lifestyle way beyond their long term means to pay.Foreclosures and Bankruptcies are very high in the mid west. Home prices are expected to stay flat in nominal dollars for years, but drop in inflation adjusted dollars.I have been searching for cash flow positive rentals in the mid west for the last three years and can't find any. There are to many newbie investors willing to buy rental prop and rent out at a slight loss to get the tax benefits. Plus, as mortgage rates rise and rents stay flat in the mid west; home prices have to drop even further to get to a cash flow positive situation. And don't forget that true cash flow positive, must include an allowance for maintenance expenses and normal wear and tear of carpets, appliances, etc.Bottom line. Now is not the time to try to enter the landlord profession. When is a good time? When 10 times sustaniable monthly rent covers 100% of fixed annual expenses, including (mortgage, taxes, repair and replacment of consumable items). Good luck to all.

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