The Business Book

153153

Farmers buying livestock at market

must—like many business owners—

pay up front. Costs, such as feed and

storage, will mount before they see a

return on their investment.

See also: How fast to grow 44–45 ■ Investment and dividends 126–27 ■ Making money from money 128–29 ■ Leverage
and excess risk 150–51 ■ Maximize return on equity 155 ■ Balancing long- versus short-termism 190–91

MAKING MONEY WORK

company may rely on dipping into
an overdraft to make up for a cash
shortfall. But when times are tough,
a reliance on the bank may be too
risky. A business needs to manage
its finances well enough to avoid
periods of negative cash flow.

How good companies fail
Cash is a constant pressure for
every new business. Even if the
company keeps to its start-up
budget, it takes time for trading
to reach a high enough level to
generate positive cash flows. For
example, a sports’ equipment
store may take three years to
build up the regular clientele that
will enable it to start making
money. Until then, the business
faces negative cash flow. So it
is crucial for new businesses to
prioritize cash flow from the
beginning. This may mean
leasing equipment, or buying it
secondhand rather than new, and
choosing suppliers that provide
the same credit period as the store
gives to its customers, even if these
suppliers cost a little more. Cash-

flow problems can also cause well-

established companies to stumble

and even collapse. In 1998, South

Korea’s Daewoo Group encountered

growing problems because of

“increasing difficulties in arranging

working capital and investment

funds.” The group had been

aggressively expanding, and

admitted that its overall financial

stability had been seriously

undermined by a new reliance

on borrowings, but insisted that

it was a brief moment of crisis.

Despite being one of the largest

conglomerates in the world, the

group collapsed the following year

due to massive cash shortfalls. ■

Money scams

US investment advisor and

financier Bernard Madoff was

sentenced to 150 years in prison

in 2009 following a money

scam that is believed to have

led to about $18 billion of losses

to investors. Although hailed

as a distinguished and expert

financier, capable of generating

very high returns for investors,

Madoff was in fact responsible

for running a “Ponzi scheme,” in

which cash from new investors

is used to pay generous returns

to earlier investors. The delight

of these early customers led

them to recommend the scheme,

which then continued to pay

earlier investors with the cash

put into the company by

subsequent investors.

This type of financial pyramid

is able to stay afloat as long

as sufficient numbers of new

savers put cash into the scheme.

If the flow of funds dries up,

the scheme collapses. Madoff’s

scam collapsed due to a loss of

investor confidence following

the 2008 financial crisis.

A business receives a $24,000 order, and has to plough cash into

making the goods. By week six, $20,000 has been spent by the company;

the customer is invoiced, but is not required to pay until week 13. This

means the company faces serious negative cash flow for 12 to 13 weeks.

10

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$0000s

1728394105111361214

WEEKS

Deliver and

invoice

Profit

$4,000