When Things Get Better - On the Numbers
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SECTION: On the Numbers

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When Things Get Better

By Garry Bartecki

Article Date: 11-01-2009
Copyright(C) 2009 Associated Equipment Distributors. All Rights Reserved.

It will be just as important to manage cash flow tightly when growth returns.

I know I have been discussing downturn issues the last four or five months, but I think we all know about that and what we need to do to come out on the other side of this industry depression. We are not there yet, but another 18 months or so should do the trick. So let’s assume you are one of the tough guys or gals who was able to ride out the storm by rightsizing the business and/or keeping fixed costs to a minimum. So, what happens when business picks up?

What happens when business picks up is both positive and negative, keeping in mind two important business axioms:
A) Cash is king.
B) Every dollar of new sales requires more capital.

Now you can see both sides of this equation. Increased business is great, but at the same time requires more capital to handle the new business and keep the cash flow at adequate levels. This should not cause a problem, but there will be a few hurdles to overcome.

You are starting the recovery with minimum cash.
2. Your equity level is much lower than it used to be.
3. New business will generate more AR and inventory.
4. Payroll and expenses will increase.
5. AP will require payments before the inventory is converted to cash.
6. The banks may not give you what you need as fast as you want it.
7. Rental requests will increase.
8. Rental fleet will need to be updated.
9. The banks may not give you what you need.

On top of that, your primary vendor probably came through with a price increase you may not be able to pass on. It may also be possible that your efficiency is not up to par because you lost so many people, and it is going to be tough to generate cash flow like you did before.

Many moons ago I made a presentation at a similar point in the economic cycle and demonstrated how easy it is to go bankrupt as a result of taking on more business than your capital structure can handle. Because of how far our industry has fallen it is not out of the realm of possibility to expect above-average growth spurts that will lead to uncontrolled or unplanned inventory levels, which can lead to a negative cash flow situation.

It is no secret that in our industry a dealer needs at least 30 percent of equity invested in total assets. To see how you stand, please check out the CODB for your size and type of dealership. You may have this goal accomplished at the moment in your downsized mode, but what if business increases by 40 percent over a 12-month period – what happens then? What happens is you have a problem if you do not keep your growth under control, a problem that can put you right back where you are now.

Double the size of the business and you need to double your permanent capital in the business. Permanent capital comes in the form of after-tax income, capital contributions from the owners, mezz fund investments, or a long-term loan of some sort that will provide capital long enough for you to "catch up" and get control of the cash flow at a higher level of sales.

Doubling up of the equity can be minimized somewhat if the growth is made up to a great extent of parts and service business because the gross profits from this type of business allows you to cover other operating expenses.

I guess where this all goes is the following:
  • The industry business model has changed
  • The recovery could be slow
  • Growth when it comes could be dramatic
  • Growth requires adequate capital
  • Cash flow modeling for different level of sales is a must
  • Being a "service center" may lower your equity requirements
  • Balance sheet management is a MUST!

So let us all keep in mind that we are not out of the woods, even if industry statistics show improvement. In fact, going forward, it will be just as important to project cash needs as it is right now.
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