Lack of cash is the main reason for business mortality. It is not just a problem for companies that lose money, it might also be for those making profits. Many companies with growth and profits go bankrupt for an unexpected shortage of cash.
Most frequently this happens to companies that have small profit margins and grow at a high pace. Growth forces them to hire more employees, buy more inventory and invest more. Cash collection after sales comes much later therefore, unable to finance growth with profits, they borrow more and more. The more they grow the less cash remains, until reaching a point at which there is no room for more debt (banks stop lending), liquidity drains and they go bankrupt.
My advice is to keep always a cushion in liquidity to anticipate surprises and to prevent a temporal shortage of cash that could destroy all value created with so much hard work.
My practice selling companies have taught me that when a liquidity crisis occurs, without regard how good the company is, investors fly scared and value plummets. Even though it should be more attractive as a bargain, experience says that most investors are fearful and don’t want to invest in troubled companies.
If you launch a growth project, be cautious. Experimenting is wise, but those tests shall be small, with measured risks. Do not go for big investments that, if going wrong, can risk the whole company. Cash is the blood of your company, be vigilant because you can bleed to death.
Author: Enrique Quemada, President of ONEtoONE Corporate Finance Group